Caution prevails over loan to parent despite Vedanta's strong Q2 show

The concerns are outweighing the improved earnings outlook led by rebound in base metals prices

A stronger-than-expected July-September quarter (second quarter, or Q2) performance announced on Friday evening saw Vedanta’s stock gain 4.5 per cent to close at Rs 98.60 in Monday’s trade.

Despite these gains and an improvement in the operating environment, Vedanta's stock, which had corrected by over 30 per cent after the failed delisting attempt by promoters, has remained range-bound between Rs 92 and Rs 105.

The reason? The Street has become increasingly cautious about high promoter debt and Vedanta's inter-corporate lending. Despite being positive on Vedanta's near-term earnings outlook, analysts have lowered their target prices.

Inter-corporate deposits (ICDs given to parent Vedanta Resources) and near-term debt repayments keep analysts at PhillipCapital cautious about the stock. They have discounted the oil and gas business cash-flow entirely on the risks of further ICD support, and have lowered their target price to Rs 126, from Rs 150.

In Q2, the improvement in zinc, lead, crude oil, and aluminium realisations by 19 per cent, 15 per cent, 42 per cent, and 10 per cent, sequentially, coupled with cost control and better volumes in zinc, iron ore, and copper businesses, helped Vedanta post significant improvement in performance.

Sequentially, revenues jumped 33 per cent and operating profit surged 63 per cent after being impacted in the April-June quarter by the back-to-back nationwide lockdowns.

Net profit, adjusted for exceptional items, at Rs 2,509 crore was up 32 per cent sequentially and came much better than analysts' estimates.

Motilal Oswal Financial Services (MOFSL) had pegged net profit at Rs 1,860 crore.

The outlook has also improved, with base metal prices continuing to rise.

Aluminium, zinc, lead, and copper prices are up 15-50 per cent, from the March-April lows. Currently, aluminium and zinc, which matter most to Vedanta, at $1,891 and $2,614 a tonne, are higher than the average of $1,704 and $2,340 in Q2, respectively.

There is steady volume ramp-up in Zinc India (Hindustan Zinc, or HZL) and Zinc International businesses.

Production uptick was also witnessed in the oil and gas division for the first time after the third quarter of 2018-19, say analysts. While all this should boost earnings, concerns about capital allocation are weighing on sentiment.

Vedanta, through its overseas subsidiary, has advanced inter-corporate loans of $956 million to its parent in three tranches between April and October, which are repayable over the next three years. Though it has assured of no further extension of cash support to the parent, given the parent leverage, Edelweiss is concerned about Vedanta's future capital allocation.

Further, analysts are awaiting clarity on distribution of HZL’s dividend received in 2020-21. “Given the capital allocation concerns, we raise holding company discount for HZL (to 30 per cent, from 10 per cent). On a sum-of-the–parts basis, we arrive at a target of Rs 104 for Vedanta,” says MOFSL.