Vedanta stock trips on pricing, supply worries, loses most gains since July

Correction in aluminium prices, concerns on increase in future zinc supplies affected investor sentiments, but analysts still positive

After continued gains in the recent past, the Vedanta stock fell by almost 11 per cent on Monday. This has erased most of the gains since mid-July. 

Vedanta, a natural resource major with interests in aluminium, zinc, crude oil, iron ore, etc, gets affected by changes in global base metal and oil prices. Thus, correction in aluminium prices on the London Metal Exchange (LME) and talks of a possible oversupply of zinc in the coming years affecting investor sentiment are no surprises. 

The two segments had contributed about two-third to the company’s segment profit in the June quarter (Q1FY19). Yet, if analysts are to be believed, corrections could offer a good entry point in the stock. Their optimism is based on improving oil prices, rising production in zinc business, and softer input prices offsetting lower aluminium prices.

To begin with, the per tonne price of aluminium on the LME, after rising from around $2,000 levels in last week of September to $2,243 on October 4, has corrected by more than 5 per cent. The price fall comes as the earlier euphoria that cost-push will keep aluminium prices firm after complete closure of Alunorte Alumina refinery last week came to an end with the refinery getting go-ahead to resume 50 per cent of its operations on October 5. 

This development is likely to put pressure on the prices of alumina, too — a key input to produce aluminium. Analysts at Edelweiss say that in the futures market, alumina is still trading at $620 per tonne, up 25 per cent over the past three sessions. However, they expect it to correct and in the medium term expect alumina/LME aluminium price ratio to be about 20 per cent, down from around 32 per cent in September 2018.

The declining aluminium prices is negative for Vedanta. However, since the company is dependent on external alumina supplies it should also benefit on the profitability front. Aluminium had contributed 17.5 per cent to Vedanta’s segment profits during Q1FY19. 

In zinc, the global supply at 13.7 million tonnes (mt) is expected to fall short of the estimated demand of 14.8 mt in calendar year 2018. However, an analyst from a foreign brokerage, on Monday, said he expects a largely balanced market in CY2019 and an oversupply situation in zinc in CY2020. Such worries also affected investor sentiment since zinc prices are now seen correcting. 

Vedanta’s Zinc India business (represented by its listed subsidiary, Hindustan Zinc) had contributed about half to the company’s segment profits in the June quarter. The solace for investors, however can come from the improving the volume outlook for the zinc segment. Although the June quarter remained subdued in terms of production, owing to the company shifting from open-cast mining to underground mining, analysts say Vedanta is on track to achieve 1.2 mt per annum run-rate by the end of FY19 from 0.95 mt in 2017-18. 

Vedanta plans to further raise its annual zinc production to 1.5 MT. The company’s Zinc International business, too is seeing rising production with new mines expected to come on stream. Thus, a better volume run-rate and favourable impact on costs with rising scale of operations should provide cushion to earnings, feel analysts.

The bigger trigger for Vedanta remains the rising crude oil prices. With prices expected to remain firm, profitability of its oil and gas should continue to get a boost. The segment contributed 26 per cent to Vedanta’s segment profits and should drive future earnings.

Against this backdrop, analysts maintain their positive stance on Vedanta. Edelweiss, for instance, has retained it “buy” on Vedanta on October 8, while a few days back Citi Research had said that expectation of falling alumina prices/bauxite sourcing cost, strong crude prices and growing international zinc business (declining costs) augur well. 

Vedanta remains a story of ramping-up operations to full potential with some capital expenditure already invested, which should translate into earnings growth and deleveraging. An interesting observation that analysts make is that 93 per cent of Vedanta’s debt is rupee-dominated and hence the depreciation in rupee does not significantly impact the company. On the other hand, revenues of most business segments are linked to global (dollar-based) prices, so a weak local currency should only help. Hindustan Zinc, having a strong balance sheet, should also continue to with its healthy dividend pay-outs, thereby benefitting Vedanta.