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Vedanta's Q1FY20 results (Neutral) - Cost reduction, volume growth to driveearnings

Q1FY20 Result Highlights: weak operating performance

• Vedanta (VEDL IN) reported lower than expected EBITDA of Rs51.98b (IDFCe: Rs56.2bn), down 15.3% qoq due to weak profitability across business segments except power and Oil & Gas. Profitability was lower in Zinc India (lower volumes and higher CoP), Zinc International (adverse product mix, lower realisation and higher CoP), aluminium (lower realisation), iron ore, and steel business (lower realisation and volume). Major segments like Zinc and Oil & gas contributed 84% to EBITDA v/s 80% in Q4FY19. Aluminium CoP stood flat qoq at US$1,875/t.
• VEDL informed that its subsidiary, CIHL, has unwinded its structured investment in Anglo American Plc via Volcan Investment, effective 26^th July, 2019. This not only resulting in a gain of ~USD100m from the transaction but also removes major overhang on the stock.
• At Q1FY20-end, Net debt ex-HZ (excluding acceptances) increased Rs30.7bn (7%) qoq to Rs470bn primarily due to working capital increase of Rs3bn.

Key Positives: Unwinding of investments in Anglo American

Key Negatives: lower volume in Zinc India, adverse mix in Zinc International and higher CoP, no CoP reduction in aluminium

Change in estimates: Cut EBITDA estimates by 9% in FY20 and by 8% in FY21 to factor in lower zinc, aluminium and steel prices

View: Reiterate Neutral with unchanged TP of Rs201

We expect Vedanta to record EBITDA CAGR of 15% during FY19-21E driven by volume growth in zinc (both India and International), and oil & gas, and lower CoP of aluminium.

The unwinding of VEDL’s structured deal with Volcan removes one layer of overhang on VEDL’s share price. Management has categorically denied any further financial transaction with the parent company (except dividend), Vedanta Resources, to meet the parent’s principal payment obligation. However, Vedanta Resources, has ~USD6.3bn debt (Rs120/sh of VEDL) which needs to be paid in future and it does not has any corresponding major operating entity besides VEDL which can help in repaying the debt. Any move by the parent in deleveraging its balance sheet by monetising assets will remove overhang on VEDL’s share price. We expect DPS of Rs17 in FY20 which works out to 10% div yield at CMP, limiting downside in the stock. We roll forward our valuation to FY21e. We arrive at a TP of Rs201 based on FY21E SOTP. We reiterate Neutral rating on the stock.