Vedanta's Q2FY20 results (Upgrade to Outperformer) - A 10% div yield restricts price fall

Q2FY20 Result Highlights: Aluminium disappoints

• Vedanta (VEDL IN) reported lower than expected EBITDA of Rs44.2b (IDFCe: Rs47.9bn), down ~15% qoq, primarily due to loss in aluminium segment and lower profits in steel business offset by better than expected performance in International Zinc, oil & gas and Iron ore segment. Ex-HZ, EBITDA stood at Rs23.6bn, down 15% qoq. Major segments like Zinc and Oil & Gas contributed 91% to EBITDA vs 84% in Q1FY20.
• With stable volume and lower discount to Brent offsetting lower crude prices, Oil & Gas reported EBITDA of Rs18.2bn (~40% of EBITDA), flat qoq.
• Aluminium reported EBITDA loss of Rs1.1bn vs EBITDA of Rs1.79bn in Q1FY20 (IDFCe: Rs2.4bn) due to lower LME prices, adverse product mix and higher fuel costs. Aluminium CoP stood at US$1,933/t, up 3% qoq. The company could not take advantage of lower alumina prices (could be due to use of high cost inventory) and also incur high power charges due to less availability of linkage coal. We expect CoP to fall by upto 10% in ensuing quarters.
• At Q2FY20-end, Net debt ex-HZ (excluding acceptances) decreased Rs73bn (15%) qoq to Rs397.4bn primarily due to operating cashflows, realisations of disputed debtors (~Rs19bn), inventory liquidation (~Rs 11bn) and increase in customer advances.

Key Positives: Steady oil & gas earnings

Key Negatives: EBITDA loss in aluminium, lower commodity prices, cut in FY20 volume guidance in zinc and oil & gas

Change in estimates: Reduce FY20 EBITDA by 17% and FY21 by 7% to factor in lower commodity prices and lower volume in zinc, oil & gas

Outlook: Upgrade to Outperformer with revised TP of Rs184

We expect Vedanta to record EBITDA CAGR of 11% during FY19-21E driven by volume growth in zinc (both India and International), oil & gas, and lower CoP of aluminium. Though the parent company, Vedanta Resources with debt of ~USD6.3bn, does not has any material principal payment obligation till FY21E, it requires money to meet its interest obligations and it does not has any corresponding major operating entity besides VEDL. As a result, we expect VEDL to provide DPS of Rs14 (~10% div yield) in FY20, beneficial for minority shareholders too. With expectation of commodity prices bottoming out and with a fall in the share price, we believe VEDL is available at an attractive price. As a result, despite reducing our target price to Rs184 (Rs201 earlier) due to cut in earnings, we upgrade the stock from Neutral to Outperformer, based on FY21E SOTP.