Vedanta going private is a sign of base metal cycle bottoming, say experts

After hitting multi-year lows, metal prices have seen some gains. Though lower input costs are supportive, demand is the crucial missing piece

Anil Agarwal is well known for his stupendous rise  — from a small metal scrap dealer in the mid-1970s to executive chairman of Vedanta Resources, which has interests in aluminium, copper, zinc, silver, iron ore, and crude oil through majority stakes in Vedanta Limited and Hindustan Zinc. Over the past 45 years, Agarwal has made at least six acquisitions and scaled up many into cash-generating businesses.

The most successful is the acquisition of a majority stake in Hindustan Zinc in 2002. His acquisition cost of about Rs 1,000 crore is now worth Rs 47,000 crore even in these depressed markets — a compound annual return of almost 24 per cent (dividends excluded) over 18 years. So, it will be safe to assume that the 66-year-old knows the metals trade and business valuations more than most ordinary investors. And now, when Agarwal is wanting to take Vedanta Limited private by buying out minority shareholders, a key reason will be that the business is available cheap. Most experts agree.

“In the promoters' view, the sell-off in metals may be overdone, and thus they could be looking to take Vedanta private at these attractive valuations,” says Deepak Jasani, head-retail research, HDFC Securities.
 

 

Ajay Bodke, CEO & chief portfolio manager (PMS), Prabhudas Lilladher, shares a similar view. “Typically, promoters want to take their companies private when the markets are not valuing them at intrinsic value. Second, the commodity business is characterised by cyclicality. Such announcements are indications that the promoters believe the cycle is near the trough.”

Bodke says  Agarwal is a savvy investor, and he may not keep Vedanta private for long (if the current bid is successful) and take it public again when valuations are favourable.

So, where does the business cycle stand currently? Prices of base metals, such as aluminium and copper, after falling to a decade and 5-year lows, respectively, have rebounded up to 16 per cent from their March-April lows. The uptick is led by the resumption of industrial activity in China and the easing of lockdown around the world. This brings respite for India's base metals players, such as Hindalco, Vedanta, and Nalco.

Yet, some analysts warn about the near-term outlook. Vikash Singh of PhillipCapital, says: “Aluminium inventories on major exchanges improved marginally to 1.78 million tonne (mt) and global and China month-on-month average daily production fell 1 per cent each to 175,000 tonne and 99,000 tonne, respectively.” Domestic demand — largely from power transmission, automobile, and construction sectors — has plummeted, points out CRISIL Ratings.

The falling coal prices, however, are a saving grace. The price of coal sold under fixed contracts is 30-40 per cent cheaper than imports and the average premium of e-auction has fallen steadily from 131 per cent in December 2018 to 36 per cent in March. “The industry's current operating profitability would still be only 60 per cent of the average per tonne profitability over the past five years,” says Naveen Vaidyanathan, associate director, CRISIL Ratings.

The rebound in metal prices and benign costs have helped stocks post gains. Hindalco, after more than halving from January highs of Rs 220 to Rs 88 in March, is now at Rs 139. Vedanta, too, has recovered to Rs 92, after falling over 60 per cent from January highs.

The sharper fall in Vedanta can be attributed to its diversified natural resources pie, where a steep fall in oil prices is hurting. Hindalco, which is also a diversified player, gets cushion from its US subsidiaries Novelis and Aleris (70 per cent of revenue), which continue to see firm profitability by being convertors of aluminium into value-added products.
 

While Jasani believes that delisting Vedanta may not be easy for its promoters as the large institutional investors will not agree at current price offered, what is the advice for investors looking to invest in metal stocks. “Metals is a very cyclical industry and most companies are highly leveraged. In good times companies enjoy fat margins and operating leverage, and in bad times many go bankrupt. Now we may be towards the lower end of the cycle, but the final panic is yet to happen,” says Jasani.

In a recent note, Vishal Chandak of Emkay Global said the pandemic will lead to a reduction in both demand and prices for most commodities in FY21. However, a revival is expected in FY22 and the normalisation of demand in FY23, driven by fiscal stimulus by large global economies.

In other words, investors with a short-term horizon may want to wait for a better opportunity and global economic growth indicators to improve. But, for those with a long-time frame, Bodke sums it up well: “If you are an optimist, you will not be holding that the economic disruption caused by coronavirus is permanent. It is a matter of time before fear psychosis subsides and normalcy prevails. Once the global trade picks up, the industrial activity will improve, too. So, what better time to pick up shares than now.”