Phillip Capital upgrades Vedanta to 'buy' on positive demerger outlook; expects 30% upside

Vedanta, India's largest diversified natural resources company, on Friday announced a strategic plan to demerge its business units into independent "pure-play" companies. This move aims to unlock value within each business segment and attract big-ticket investments for their expansion and growth.

The company's board has given its approval to this pure-play, asset-owner business model, which will ultimately result in six separate listed companies. These entities include Vedanta Aluminium, Vedanta Oil & Gas, Vedanta Power, Vedanta Steel and Ferrous Materials, Vedanta Base Metals, and Vedanta Limited.

The de-merger is planned to be a simple vertical split, for every 1 share of Vedanta Limited, the shareholders will additionally receive 1 share of each of the 5 newly listed companies. The entire process is expected to be completed by September FY25.

Global brokerage firm Phillip Capital is optimistic about Vedanta's strategic move, foreseeing positive long-term effects. It says the demerger offers the group increased flexibility, unlocks value for investors by allowing them to select specific commodities for investment, and provides the parent company with the option to liquidate assets partially or fully to manage debt repayments.

Debt servicing – caught between a rock and a hard place

Vedanta’s parent company (VRL) is facing an uphill task in managing its debt maturities. It has repayments of US$ 1.3–1.4 billion in the next six months, including bond payments of US$ 1 billion in January 2024 and US$ 3 billion in FY25, plus interest-servicing requirements.

This is becoming increasingly difficult, considering that cash flows from subsidiaries have contracted due to the weak commodity environment; Hindustan Zinc's cash balance is fully exhausted, and interest rates have increased amid downgrades by credit-rating agencies, said Phillip Capital.

"VRL’s main source of income to service debt is brand fee and dividends. However, with commodity prices nose-diving, brand fee and dividends will see a sharp fall over the previous year, pushing VRL against the wall. Poor credit rating makes it difficult for the company to refinance its debt at good rates, and this ability remains a key trigger for stock performance", the brokerage stated.

Upgrade to 'buy'

Vedanta's stock has seen a 20% decline since the brokerage released 1QFY24 result update. Although 2Q average base metal prices are anticipated to decrease by 1-5% sequentially, the brokerage believes the company's lower cost of production (CoP) should assist in maintaining healthy margins.

Furthermore, the recent recovery in commodity prices, now slightly surpassing 1Q average levels, is expected to contribute to improved operating performance in 2HFY24, it added.

Phillip Capital believes that Vedanta Resources Limited (VRL) will be able to manage its debt obligations, either through partial payments or refinancing its debt (at higher costs), thus avoiding a default. Simultaneously, the demerger will provide VRL with the flexibility to sell specific assets partially or in full, facilitating the management of FY25 repayments.

Anticipating no substantial downside in the stock from current levels, the brokerage has maintained its STOP-based target price at ₹290, representing a 30.63% increase over the previous closing price, and upgraded its rating on the stock to ‘buy.’

13 analysts polled by MintGenie on average have a 'hold' call on the stock.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie. We advise investors to check with certified experts before making any investment decisions.