Vedanta Ltd.: Undervalued and Attractive for Long-Term Investments
- By Subia Khan
Vedanta Ltd. (VEDL) is a diversified natural resources company involved in exploring, extracting and processing minerals, oil and gas. The various natural resources of the company include oil and gas, zinc, lead, silver, copper, iron ore and aluminium. Vedanta also operates various power plants in the Indian states of Odisha, Chattisgarh and Tamil Nadu. Vedanta has already produced 128% returns in the past year and I believe the stock will continue to reward investors in the coming years.
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The intrinsic value of VEDL
One of the foremost reasons to like Vedanta is the fact the company was able to deliver an EBITDA margin of more than 32% for the first quarter of 2017 in spite of high market volatility.
Below is the EBITDA mix of the company, with the zinc segment contributing 37% due to being a low-cost segment. The oil and gas segment's EBITDA contribution was 22%.
Zinc India is well positioned to reap benefits from strong fundamentals, as the company has been aggressively involved in its mining activities and is expected to increase production in 2017. According to the company's presentation, production in the second half of the year will be better than in the first half. Similarly, production in the second quarter of 2017 will be better than in the first quarter. This is not just in reference to Zinc India, its international segment is also expected to provide high returns. The Gamsberg project is expected to start in 2018 with full capacity production of 250 karats by the end of fiscal 2019. The project has a strong EBITDA visibility, which will further add to the company's overall EBITDA margin growth.
With commodity prices recovering since February and economic conditions getting better in China, investors are regaining confidence in the industrial commodities sector. I am expecting bullish momentum for commodities to continue in 2017. This will have a positive impact on the company's EBITDA margin.
From a financial perspective, the company is stable and is generating sufficient free cash flow to meet its capital expenditure requirements and maintain a strong liquidity buffer. The company is involved in the ramp up of capacities at its aluminium, power and iron ore business, which is expected to boost EBITDA by more than 30%. Moreover, continuous strong cash flow is expected from Hindustan Zinc and Cairn India, which will provide higher free cash flow. This will help the company deleverage its balance sheet.
Vedanta currently has total term debt of $7.8 billion with external term debt of $4.9 billion and $2.9 billion debt at subsidiaries. As of June 30, 2016, the company had debt maturity of $1.9 billion for fiscal 2017 and $1.6 billion for fiscal 2018. Considering strong cash and cash equivalents of $7.7 billion and an undrawn committed line of $1 billion, the company has sufficient liquidity to meet both its short-term obligations of $3.5 billion (total debt for 2017 and 2018) and capital expenditure requirements of an estimated $1 billion for fiscal 2017.
Even after meeting its debt and capital expenditure requirements, Vedanta will have around $4 billion in excess cash that could be used to create shareholder wealth through dividend distribution. Thus, I believe Vedanta's focus on strong free cash flow generation through well-planned ramp ups across segments will help the company to grow, keeping the stock attractive for long-term investors.
From a valuation perspective, the company looks attractive. Vedanta is currently trading at EV/EBITDA of 5.2. In comparison, Freeport-McMoRan (FCX) and Rio Tinto (RIO) are trading at an EV/EBITDA of 12.5 and 9.7. The valuation gap implies Vedanta is undervalued and investors can reap the benefits in the medium to long term through meaningful stock upside.
Cairn India's merger with Vedanta will make the stock even more attractive, as I believe the oil and gas segment will provide huge upside to EBITDA. With oil prices trending higher and lower per-barrel costs of production, I believe the oil and gas segment will be the next big EBITDA contributor for Vedanta. Thus, considering a well-managed operation and diversified natural resource entity, the stock has room to grow and provide good returns to investors.
Disclosure: No position in the stocks discussed.
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This article first appeared on GuruFocus.
Warning! GuruFocus has detected 2 Warning Sign with VEDL. Click here to check it out.
The intrinsic value of VEDL
