On June 17, Bill Simpson wrote an analysis of Sterlite Industries India Limited (SLT). On June 19, the company sold 130.44 million of its equity shares in the form of American depositary shares [ADS], for $13.44 each. The gross proceeds of the offering totaled approximately $1.75B. The stock closed on June 22 at $14.80.
The text of Mr. Simpson's original writeup follows:
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SLT - Sterlite Industries
Sterlite Industries (SLT) plans on offering 125 million American Depository Shares [ADS] at an estimated price of $14 per ADS. Each ADS is equivalent to one share. This offering includes 113.5 million ADS on the NYSE and 11.5 million ADS in Japan. The ADS offering in Japan will not be listed in an exchange. Merrill Lynch, Morgan Stanley and Citibank are lead managing the deal, Nomura co-managing. Post-offering SLT will have 683.5 million shares outstanding for a market cap of $9.57 billion on a pricing of $14. IPO proceeds (which will be significant at an estimated $1.65 billion) will be used for general corporate purposes.
Note - The SLT offering on the NYSE is technically a secondary, as Sterlite is currently listed and traded in India on the NSE and the BSE; it is also a component of the exchanges’ major index. Over the past year, SLT's dollar adjusted shares have traded in a range of approximately $6 - $14. Like many foreign stocks trading elsewhere in the world, they tend to make their debut in the US right at all-time highs in stock price. The overall trend has been an initial 'sell the news' on the US debut, although that is not an across the board trend.
Vedanta Resources, a listed London metals and mining company, will own 60% of SLT post-offering. Vedanta ipo'd in London in late 2003 and is up over 300% since ipo.
From the prospectus:
We are India’s largest non-ferrous metals and mining company based on net sales and are one of the fastest growing large private sector companies in India based on the increase in net sales from fiscal 2006 to 2007.
SLT operates three primary businesses in India:
1) Copper - SLT is one of the two custom copper smelters in India, with a 42% primary market share by volume in India in fiscal 2007. In 2006, SLT was the worldwide 5th largest custom copper smelter and operated two of the five lowest costs of production copper refineries in the world.
2) Zinc - SLT is India’s only integrated zinc producer and had a 61% market share by volume in India in fiscal 2007. SLT's zinc mine is the third largest in the world in terms of production and 4th largest on a reserves basis. SLT operates both zinc mining and smeltering operations in India. SLT has plans to open an additional zinc smelter over the next couple of years.
3) Aluminum - one of four primary aluminum producers in India, with a 25% market share in FY '07. In addition to current production, SLT owns a 30% minority interest in Vedanta Alumina. Vedanta Alumina has commissioned a new 1.0 million tons per annum aluminum plant in India. While initial product is expected to be shipped from the plant beginning in June 2007, it will be 2009-2010 before the plant is shipping extensive product.
In addition to copper, zinc, and aluminum, SLT is getting into the power generation business in India. SLT has experience in building and managing the seven power plants that service their metal smelting operations. SLT is now investing $1.9 billion to build the first phase, totaling 2,400 MW, of a thermal coal-based power facility expected to be complete in 2010. This is an aggressive investment for SLT, as the power plant will be 2 1/2 X's the size in terms of power generated as all of their smelter power plants combined. This facility will be used to sell power to the Indian power grid.
SLT has grown revenues swiftly the past three years due to capacity growth and commodity price increases. Really SLT has been positioned perfectly over the past 3-4 years. If this entity had come public 4-5 years ago it would be one of the biggest winners this decade. Keep in mind that here in 2007, SLT is coming to the US with a $9.57 billion market cap, far far higher than wold have been the case had they listed in the US closer to the beginning of the commodities boom.
Being located in India, SLT enjoys a low cost of production making them quite competitive in the world commodities market. SLT enjoys a leading market share in India in all three of their primary business lines, Copper, Zinc and Aluminum production.
While zinc mines much of their own end product, they source the majority of their copper and aluminum requirements from third parties. Copper concentrate is purchased on the London Metals Exchange, alumina from third party suppliers.
78% of revenues are derived from sales in India and Asia combined.
There appears to be some issues in the divestiture of the Indian government’s minority ownership in both SLT's aluminum operations and zinc operations. The Indian government currently owns 49% of SLT's aluminum operations and 30% of SLT's zinc operations. The issue with the zinc operations actually pertains to the government of India's original divestiture of 64% of the zinc operations to SLT earlier this decade. This one by a public interest group appears to have little chance of success. In 2004, SLT exercised an option to purchase the remaining 40% Indian government interest in SLT's aluminum operations. The Indian government has and still is disputing this exercise.
As of 6/07, there has been no resolution. There is also another issue with SLT's optioning the 30% remaining Indian government interest in the zinc mines. This pertains to claims that SLT did not act in the best interest of India. This one has been dragging on for over 5 years, although there has been no further action by the Indian government since 2005. If down the line the Indian government again asserts these claims and were to eventually win the resulting legal case, the penalties for SLT are quite harsh. I've no idea what the chance of this happening may be, although it would appear this would not occur for 4-5 more years at least....and it appears the Indian government may have decided to drop this last one altogether.
Also, it appears SLT plans on ending this, by issuing a 'call right' in which SLT would overpay the Indian government for their remaining 30% interest in SLT's zinc operations. SLT is actually planning on using the ipo cash for this very purpose. I think the takeaway here overall is that government intervention is a definite risk here. At the least, SLT has extensive regulation and a not so silent partner in the Indian government. If for some reason the government of India shifts to a more anti-capitalist stance, operations such as SLT would indeed suffer. In other words, public shareholder would suffer.
Stating the obvious, but should the strong commodity market of the past 5 years turn down, SLT would definitely be affected. With the continued strong growth in Asia and India, it would probably take a prolonged worldwide economic slump for this to occur.
SLT's fiscal year ends 3/31 annually. FY '07 ended 3/31/07.
$1.8 billion in cash post-ipo, $300 million in debt. SLT will most likely use the cash on hand to purchase the Indian government’s minority ownership of SLT's zinc operations. This is not a given however.
SLT has paid dividends in the past and plans to in the future. Dividends are payable annually soon after the end of the fiscal year(3/31). FY '07's dividend was equal to $0.075 per share. On a pricing of $14, SLT would be yielding 1/2 of 1% annually.
2 1/2 X's book value on a pricing of $14.
Fueled by the strong commodity market in both demand and price, SLT doubled revenues in FY '06 and then again in FY '07.
FY '07 (ending 3/31/07) - Revenues increased by 100% to $5.65 billion. Copper operations accounted for 47% of revenues, zinc operations 33% of revenues and aluminum operations 20% of revenues. Gross margins were a strong 40%. Operating margins were 38%. SLT's tax rate was 27%. Net margins after taxes were 28%. After removing minority interests (which will remain post-ipo also), net earnings were $1.61.
On a $14 pricing, SLT would trade 9 x's trailing earnings. Interestingly, the bulk of SLT's net earnings are derived from their zinc operations. While the zinc operations accounted for 33% of revenues, they accounted for 60% of operating profits. Pretty easy to discern the reason: SLT mines the majority of their own zinc production, while they source the majority of their raw aluminum and copper.
The cost of production for their zinc operations remains rather constant even with the underlying commodity price rise. Because SLT mines their own zinc they're able to benefit from any commodity price rise of zinc in their end selling price. While they're able to pass along the commodity costs of the procured aluminum and copper, their raw materials costs in these two segments rises with the underlying commodity price rise.
The following fueled earnings for SLT: 'The daily average zinc cash settlement price on the LME increased from $1,614 per ton in fiscal 2006 to $3,581 per ton in fiscal 2007, an increase of 121.9%.' SLT's operating margins in their zinc business literally went through the roof in FY '07 to the tune of 73%!
FY '08 (ending 3/31/08) - Copper and aluminum are low margin segments for SLT, as long as zinc prices remain robust, SLT will produce strong results. Through the first quarter of FY '08, zinc prices have remained quite strong. Results for FY '08 will also depend on SLT's ability to purchase the Indian government’s 30% remaining stake in SLT's zinc operations. If they're able to reclaim this stake, the bottom line should grow nicely the remainder of the fiscal year as few earnings in SLT's zinc operations will be funneled off to minority investors. SLT has increased capacity each of the past two years across their operating segments. I would anticipate a 5% -10% capacity increase in FY '08. Assuming a continued robust end market price/demand wise for copper, aluminum and (especially) zinc, I would expect to see SLT grow the top-line by 10%-15% in FY '08.
This does not assume SLT is successful in buying that 30% zinc stake from the government. Bottom line could grow 20% due to very little relative GSA expense. Earnings per share on $6.4 billion in revenues would be $1.80 - $1.90.
It is important to note that these estimates assume rather flat commodity prices in 2007, no large gains or dips in aluminum, zinc and copper. Zinc is the one to watch here. If zinc prices fall, SLT's earnings will as well. If SLT earns $1.80 - $1.90, on a pricing of $14 it would trade 8 x's FY '08 earnings.
Power generation is sort of the wild card here. While SLT already operates seven power plants that supply power to their metal production facilities, they're planning construction of a general power plant. This plant will not be online until at least 2010.
The other wild card is SLT's ability post-offering to purchase the remaining 30% interest in their zinc operations from the Indian Government. If this transpires, and if the price of zinc remains strong, SLT's earnings will be substantially higher then projected.
SLT will be an institutional favorite on offering. There are a huge number of shares being offered here. Also there most likely will not be the usual 'ipo effect' as SLT is already trading in India. The result should be a rather muted opening here. This is a solid operation, printing money in this commodity bull run the past few years. If this were a straight ipo with fewer shares, this would be a 'must own' on the offering price of $14.
I like this deal even with the large number of shares and that it is a secondary coming to the U.S. market at all-time trading highs. Keep in mind the huge number of shares in this deal (125 million) and the run-up to all-time highs for Sterlite on the Indian exchange pre-US offering. Plus this deal is pretty substantially dilutive, adding 23% to SLT's worldwide market cap.
I like this company, and think the deal works over time. The external factors mentioned just prior, however, should really mute near-term performance. I would be very surprised if SLT appreciated substantially near-term. Over time, if the price of zinc remains strong, SLT will do quite well.
Also keep an eye on SLT's efforts to purchase the Indian government's 30% stake in SLT's zinc operations. If they're successful that could be a nice bottom line driver in a strong zinc pricing market.
Recommend the deal, but with substantial near term deal-related headwinds would not expect much appreciation here near term. Recommend as mid-term plus play in a strong zinc pricing environment.