Vedanta: A Lot Can Happen In Three Months
Summary
- The parent company’s desire to increase its stake in VEDL via an open offer has been instrumental in driving the stock.
- It remains doubtful if VRL was able to garner the entire 17.5% targeted stake as the offer price was still significantly below the range quoted by key institutional investors.
- The potential acquisition price of BPCL has gone up even further and VEDL could be better served by diverting its attention to rebuilding its copper capacity.
- The aluminum CoP moved up sequentially, closer to the $1,400/tonne mark, although the company is in the midst of pushing through structural changes that could bring this down to the $1,200/tonne.
- On the charts, the stock still has upside potential for another ~15-16%, but the outcome of key corporate actions could result in a lot of uncertainties.
Context of the article
The Vedanta (NYSE:VEDL) story can be viewed via two broad perspectives: there’s the core business side of things, and then there’s the corporate action/capital allocation angle. I’d touched upon some of these issues in my previous article on VEDL; my big picture take was that whilst I liked the company’s diversified and low-cost expertise across various metals/commodities, I also felt that the cloud of uncertainty hovering around recent corporate actions, and a general lack of regard for minority shareholders could throw a spanner in the works. Alternatively, I’d also stated then that for technically minded investors, the risk-reward on the charts looked rather attractive for a long position.
Well, it’s only been about 3 months since my last article, but there have been quite a few new developments related to VEDL, and I thought I’d use this opportunity to keep interested investors abreast of some of these outcomes.
The recent open offer has been instrumental in driving the VEDL stock
Hitherto, VEDL has enjoyed a stellar run in 2021 (up by around 40%); whilst the prospects of commodities and metals have been looking up, VRL’s decision (the parent company) to acquire VEDL shares via an open offer has been one of the primary drivers for the share performance this year.
As mentioned in my previous article, VRL had failed to delist VEDL last year, and whilst there were suggestions that they would attempt to have another go in 2021, I expressed doubts over whether they would be able to successfully acquire all the shares due to the wide discrepancy in the valuation (key institutional shareholders such as LIC had offered to sell only at the rate of Rs.320 per share, almost 4x what VRL was offering at Rs.87.50 per share). Getting consensus is also particularly challenging when your shareholding structure is particularly fragmented (see chart below where the non-promoter share is unevenly split amongst a whole host of parties ranging from foreign institutional investors, domestic institutional investors, mutual funds, non-institutions, etc.).
Source: BSE India
Well, as expected in Jan. '21, VRL came back with another offer, stating its intention to acquire a 10% stake of the voting share capital (371.7m shares) at Rs.160/share. This was then bumped up even further in March with the company stating that they were looking to acquire a 17.5% stake of the voting share capital (651m shares) at Rs.235 share! Considering that they only offered Rs.87.50 per share in the October 2020 attempt to delist, this is quite a leap! Ostensibly, considering the premium on offer, plenty of minority shareholders have been keen to tender their shares, but one won't know the final outcome until much later (the open offer began on March 23rd and is due to finish today).
That said, I remain doubtful if they would have successfully managed to garner the targeted 17.5% stake, as the acquisition price of Rs.235 share is still ~36% lower than what notable institutional investors such as LIC were demanding, back in October 2020, and considering the improved prospects of commodities since I see no reason why they would drop their demands. As of March 2021, LIC still accounted for the top slot amongst major public shareholders (5.58%), and I’d be quite surprised to see this figure dip post the closure of the open offer.
Source: BSE India
S&P revises rating on VRL
As mentioned previously, VRL - the parent, has been desperate to increase its stake in VEDL as it will enable them to simplify their holding structure and also tap into VEDL’s superior cash position (as of Dec '20, cash and cash equivalents worth $3.7bn, Source: Dec '20 PPT) and garner superior dividend distributions. This will potentially help them gain favor with the rating agencies, and we saw some evidence of this in Q1 after VRL first announced its decision to acquire a 10% stake via open offer. Post this news, S&P Ratings upgraded VRL’s rating from stable to negative. I suppose the decision to increase the open offer from 10% to 17.5% should be taken even more favorably by the rating agencies, but we’ll have to wait and see if they were able to successfully procure the targeted number of shares.
Potential acquisition price of BPCL has gone up even further
Earlier, I had expressed some discomfort at VEDL’s recent intentions to secure a 53% stake in the Indian oil refiner BPCL, more so at a time when there are plenty of question marks over the capital allocation policy of the firm. Discussions are still ongoing and VEDL is currently competing with two other global parties in this regard (The Indian government is looking to wrap this up by the end of Sep). Back then, reports had pegged a potential acquisition cost of anything between $8bn-$10bn and I felt it was a bad move to be chasing a carbon-heavy asset, and loading the balance sheet with even more debt ($8.5bn as of Dec '20). Now, we have even more clarity.
Well, as per the latest reports, the government of India is looking at an acquisition price of anything between Rs.700-750 per share, which would represent an exceptionally hefty premium of around 65-70% of the current price. In effect, the potential acquirer will have to shed out over Rs.80,000 crores, which will be closer to around $11bn or so. Just for some perspective, VEDL’s consolidated net debt as of Dec '20 stood at $8.5bn. Mainly on account of increased dividend outflow and inter-company loans to the parent-VRL, VEDL’s standalone net debt/EBITDA figure continued to trend up sequentially in the Dec quarter. The net debt/EBITDA figure now stands at 1.5x; worth highlighting that just a few years back in FY17 this was only 0.4x!
Source: VEDL Q3-21 Presentation
Looking to rebuild copper capacity
Rather than spend the money on carbon-heavy oil assets, I’d prefer to see VEDL divert this to more promising areas such as copper (In my coverage of DBB, I’ve written in detail about the attractive long-term prospects of copper). Besides, also note that India currently suffers from a lack of ample copper capacity (last year, for the first time in many years, India became a net importer of copper).
Do note that in 2018, VEDL had seen its Thoothukudi-based copper production unit (which belongs to its subsidiary –Sterlite Copper) shut down due to environmental concerns. Reports now suggest that it is looking to invest Rs.10000 crore to set up fresh copper-producing capacity to the tune of 500 kilo tonnes per annum in the coastal areas. Yes, there will be pressure on the balance sheet, but this is an area they should be directing capital to, as it could pay off significantly in the long run.
Aluminum CoP spikes closer to $1,400/tonne although there are plans to bring this down to $1,200/tonne
The Aluminum business is key for VEDL as it has the largest impact on Group EBITDA. Recently the company has been doing well to control its costs. I had previously expressed doubts over whether VEDL would be able to maintain its Cost of Production at around the $1,268-$1,288/tonne mark seen in H1-21. This eventually rose in Q3 by ~7% to hit $1,388/tonne. Much of the spike was on account of higher prices of imported alumina (linked to the LME index), and higher costs of domestic coal. Looking ahead, there’s not an awful lot they can do on the imported alumina front, but there is a concerted effort to make some structural changes to bring down the costs back to the $1,200/tonne range over the next couple of years.
For instance, they are looking to increase the sourcing of local bauxite from areas such as Odisha, they are also looking to participate more actively in e-auction of coal where the premiums are lower. To ensure longer-term coal security, the company recently bid and won a coal block in Radhikapur from the Government of India. All in all, despite the recent spike, one has to credit the company for making structural improvements as just as recently as FY19/20, the CoP was at a far superior level (for instance in 9M19/20, the Aluminum CoP was at $1,769/tonne vs the recent 9M figure of $1,315/tonne - Source: Q3 Presentation).
C-suite resignations
This is something that has not yet had any great impact on the shares, but I do wonder if there is more to it than meets the eye, because there seems to be something of a trend here off late. In a surprising turn of events, VEDL, on Feb 22nd had announced that their CFO would be leaving after 8 years at the company (4 years of which were spent as CFO). The announcement was made post-market hours, but it seemed like business as usual on the 23rd of Feb with the VEDL share showing no ill effects. VEDL is yet to announce a replacement.
Interestingly, this comes on the back of developments in Hindustan Zinc (do note that VEDL has a 65% stake) who also saw its CFO resign on Jan 26th, 2021. Ultimately, this could be nothing, but it is unusual to see top-level churn in quick succession.
Closing thoughts
For the technically minded, I still see upside potential in VEDL for another 15-16%, with the stock yet to hit the upper boundary of the long-term descending channel at around the $15 levels.
Source: TradingView
VEDL’s surge in recent months has primarily been driven by the parent’s desire to increase its stake via the open offer, and the premium it has been willing to pay. Generally, favorable tailwinds in the commodity space have also aided interest in this counter. From a core operations perspective, I don’t foresee any major headwinds for VEDL (although the growing indebtedness is something to watch), but the outcome of certain corporate events could result in significant volatility ahead. I’d be very surprised if some of the large institutional shareholders had tendered their shares at the offered price of $235 per share; if they haven’t, will VRL come back again with a higher bid later in the year, or will they put an end to this? Would the rating agencies be satisfied with that outcome? Will VEDL then have to give out more inter-corporate loans and direct more dividends to the parent (which would otherwise have gone to the minority shareholders)? Issues such as this could dictate the direction of the share over the next few months. I’d also be watching out for developments on the BPCL deal front and if VEDL fails to make the cut, this may well prove to be a blessing in disguise.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (11)
A nice way to play Silver upside and basic metals.
I really don't understand what is he waiting for.
Time certainly hasn't played to his benefit.
Had he offered $10 a year ago - the company would be his already
Had he offered $13 a month ago - the company would be his already
Now, he needs to offer $15+, and even that isn't certain
Materials are on fire (seekingalpha.com/...) and a taking private seems like it's burning out...
www.nasdaq.com/...
India badly needs to restart its copper production to reduce it's copper imports. VEDL might get good Govt support in their quest for a new less polluting copper smelter.
Always liked the prospect of VEDL becoming the world's third largest Silver producer with their stated goal of 800 tones Silver within the next two years. They produced 610 tones in 2020.