Hindustan Zinc buyout crucial for Sesa Sterlite to repay loans

Latter facing double whammy of high dollar debt and no progress in Lanjigarh alumina project

For the London-headquartered Vedanta group, acquisition of the government’s stake in  Hindustan Zinc Ltd (HZL) is important, as it will give the Anil Agarwal-led company access to HZL’s cash reserves to pay the loans taken to acquire Cairn India.

With its Lanjigarh alumina project showing no sign of revival due to lack of bauxite, HZL is turning out to be the key company for Vedanta’s India operations. Post the restructuring of its India business under the newly merged entity, Sesa Sterlite, analysts say the new company is getting a mix of good firms with high return, high cash flowing oil and gas division and weak ones like high debt Vedanta Aluminium.

But with the Goa and Karnataka mining issue expected to be sorted in the next three months, the cash flow of Sesa Sterlite will improve. A reduction of export tax for iron ore will help the company to improve its cash flow.

According to Morgan Stanley, Sesa-Sterlite’s Indian zinc assets are among global cost leaders and growing at a robust pace.

“We forecast compounded annual growth of about seven per cent in 2013-15 for volumes of total mined metal. The division will also gain from a depreciated rupee. Zinc will continue to be among the cash cows for Sesa-Sterlite, and will be amongst the highest contributors to Sesa-Sterlite’s good return ratios,” says a Morgan Stanley analyst.

Sesa Sterlite had acquired the loan from Vedanta worth $5.9 billion and it will have access to Rs 13,000 crore from Cairn India’s balance sheet to repay loans. But this will not be enough and it wants access to HZL’s cash reserves — a company which turned around under Vedanta's management.

As the government is still holding 29.5 per cent stake in HZL, the group was unable to access the Rs 21,000 crore of cash and investments.

Bankers say after buying the government’s stake, Sesa Sterlite will be able to dip into the cash reserves of HZL to help it repay Cairn’s loans as almost $3.5 billion, which are coming up for repayment in the next three years. A merger of HZL and  Sesa Sterlite will be initiated by the first quarter of next financial year, bankers say.

The prospect of its three large projects under Vedanta Aluminium — the $2.92-billion aluminum smelter, $1.57-billion  alumina refinery, and $0.15-billion debottlenecking project — remaining bleak primarily due to unavailability of bauxite is what’s worrying analysts.

While the company has made efforts to secure alternative sources of bauxite by acquiring a 24.5 per cent stake in Larsen & Toubro’s Raykal Aluminum that holds certain prospecting licences for bauxite, analysts say they will not be surprised if the company decides to write down some part of these assets in the next one-two years.

According to the company, $3.37 billion has already been spent on these projects till March this year. With the Niyamgiri hill bauxite mines now out of bounds, the company has asked the Orissa government to arrange for bauxite mine. If the bauxite issue is not sorted out soon, it will financially impact the new merged entity negatively.

Another important factor is that about 60 per cent or about $8 billion of Sesa-Sterlite’s loans are in US currency. For every five per cent depreciation in the rupee, the long-term liability of Sesa Sterlite goes up by about $400 million.

But the good news is that zinc and aluminum prices in India are set on the basis of import parity, and hence, can gain from rupee depreciation.  In addition, almost 35 per cent of sales volumes are sold in the export market, thus having a favorable impact on the Sesa Sterlite.