We have reduced our estimates for Sterlite Industries Limited (SIL) to account for the sharper-than-expected downturn in the global economy and the subsequent slump in metal prices.
Meanwhile, SIL’s stock has fallen by more than 50% since our last quarterly report and we believe that the current price more than factors in the prevailing uncertain economic conditions.
SIL is aggressively expanding into the power business. Its plan to set up a 2,400 MW power plant in Jharsuguda is on schedule; the first unit of the project is expected to be commissioned by the end of 2009.
Furthermore, SIL has won a tender to set up a 1,980 MW power plant in Talwandi Sabo, Punjab. The power generated from this project will be sold at a tariff of Rs. 2.86 per unit.
Thus, we believe that power will be a major revenue driver in future and should cushion it from the cyclicity of the metals business.
With the turnaround in the commodity cycle, metal prices have plunged more than 50% from their highs witnessed only a few months back.
The prices of aluminium, copper, and zinc have declined substantially and inventory levels have increased as demand for metals has fallen due to the downturn in the global economy.
With the advanced economies entering into a recession and the emerging economies slowing down, demand for metals is expected to be subdued in the coming quarters. Subsequently, while prices are expected to remain soft, the decline in demand for metals will put pressure on the Company’s volume as well.
On the other hand, being a low-cost producer of zinc and aluminium due to its backward integration, we believe SIL will be able to maintain its profitability even in the challenging price environment.
We have valued SEL by using the Sum-of-the-Parts (SOTP) method. We have valued Hindustan Zinc, BALCO, and Sterlite Industries (standalone business) by using the DCF methodology. SEL and Vedanta Aluminium Ltd. (VAL) have been valued based on their estimated book values.
Our target price of Rs375 suggests a potential upside of 50% from the current market price of Rs250.05. Hence, we reiterate our BUY rating.