Friday, 30 January 2015

Vedanta (VED) ... in for a penny

Friday 30th January 2015

Vedanta (VED LN, mkt cap £1,021 million) has fallen by some 68% since its 2014 peak, to 371p/shr. In the twelve years or so since it floated, VED has been as high as near 3,000p/shr but is now right back down to below its IPO price from 2003.

Vedanta - share price since 2003 IPO
Source: Bloomberg
That Vedanta has fallen in recent times is probably no great surprise. After all, oil, iron ore, zinc, copper, you name it, have each fallen precipitously at various points during recent years. Whether this decline in general commodity prices is set to continue, I do not know. Momentum would suggest it is likely. But it's worth noting that some are now approaching the lows that were seen during 2008-09. Perhaps those lows will act as a some support? Perhaps they will be breached and demonstrate that the global troubles that erupted some seven years ago have yet to be adequately solved?

Commodity prices since 2000 - Iron ore, Oil, Copper, Zinc, and Aluminium
Source: Bloomberg
On the flip side, at some stage, the collapse in oil prices in particular, should prompt consumers to spend their fuel/energy related savings elsewhere. Deflation in non-discretionary goods might end up spurring inflation in discretionary items. Further, monetary conditions generally remain as loose as ever with regards to interest rates, although exchange rates are more volatile and tighter/looser for different regions.  

The principal risk to Vedanta and all other commodity based players is that the price of their goods continue to drop. But it's safe to say that commodity prices won't go to zero, so investors will have to take a view as to where the bottom is to be found.  

In for a penny

Where Vedanta differs to its peers is in the composition of its share holding. Some 89% of its share issue is in the hands of five holders. Just shy of 70% of the issue is held by its founder, Mr Anil Agarwal, through Volcan Investments.

Vedanta - share holder register
Source: Bloomberg
So while resource company valuations will depend on general investor appetite for risk and views on the outlook for commodities, Vedanta's may rest more heavily on the view of one individual; its chairman and major owner, Mr Anil Agarwal.

Mr Anil Agarwal's last big splurge on Vedanta was in February 2013. Back then he purchased over 5 million shares at around £12.50 per share; some c. £64 million worth. This nabbed him an additional 1.8% of the shares in issue. His timing was not great. £64 million today would get him an additional 6% of the shares. So two years later, he may well decide in for a penny in for a pound, or in for 70% in for the whole kit and caboodle. Were he to buy in the remainder of the shares in issue, this may be at a cost of between £350 to £470 million; or somewhere in the range of 370p to 500p per share. And why not?    

At its last set of interims to 30th September 2014, Vedanta reported net assets of $16.9 billion or c. £11 billion. I would add that this is also pretty much its tangible net asset value. This suggests that the shares currently trade at a 90% discount to its tangible NAV. Whether the value ascribed to its tangible assets is altogether accurate I am unsure, but a 90% discount does leave one with some margin for error.    

Of course, gross debt is remarkably high as compared to its market capitalisation. Gross debt was reported (this morning) to have totalled $16.8 billion (c. £11.1 billion) as at 31 December 2014. However, the group also has cash and liquid investments of $8.0 billion (c. £5.3 billion), meaning net debt stands at $8.8 billion (c. £5.8 billion).

And there is some market concern over the group's debt and its covenants. The covenants centre on meeting a fixed charge cover ratio, a net borrowing to EBITDA ratio, total net assets to borrowings ratio and net interest expense to EBITDA. However, the group has reported today that debt maturities total $1.273 billion for FY 2015 and $1.450 billion for FY2016. Further, that it has access to various sources of funding and no doubt potentially cheaper sources of funding than that which it presently services. Incidentally, EBITDA was down 7% YOY in the nine months to 31st December 2014, yet this is still a decent performance totalling $3,120 million.

Why the market has concern over the group's ability to service its debt and risk of refinancing is beyond me. Firstly, Vedanta is on track to haul in consensus EBITDA of $4,254 million for FY2015. And EBITDA has historically provided a good steer on operating cash flow. Secondly, free cash flow is forecast at $872 million for FY2015. This will come on the back of $1,096 million and $1,346 million free cash flow achieved in 2013 and 2014 respectively. And finally, does the market really reckon that Mr Anil Agarwal, with 70% of the equity nor for that matter likely the Indian State is going to come close to seeing Vedanta default on its debt?

Price to 2 year forward earnings - Vedanta, Rio, Vale, BHP, Anto
Source: Bloomberg
Price to book  - Vedanta, Rio, Vale, BHP, Anto
Source: Bloomberg

And another thing

Vedanta yields a whopping 11% on its prospective dividend. This is a chunky yield, yet comes at a cost of c. $173 million or c. £114 million. In the grand scheme of things, this is not a lot for it to pay.

Prospective dividend yields - Vedanta, Rio, Vale, BHP, Anto
Source: Bloomberg

And one more thing

I am reliably informed that the short interest stands at 2.3%. This is not in itself a high figure, yet if you recall, 70% of the issue is held with Volcan Investments, and a further 21.68% is held with seven institutions. One would imagine that these are unlikely to be sellers in great size at these levels. Hence, while the short interest may stand at 2.3%, there is likely to only be c. 8.5% of the outstanding available to cover. You might therefore conclude that short interest on that basis is closer to 27%.

I am long Vedanta from 390p/shr and added a few more today.



  1. Does your analysis take into account minority interests in the company? For example, the company had slightly negative net income last year because a billion dollars in income went to minority interests.

    To be honest, I've never quite understood how to translate minority interests in earnings to free cash flow--do you reduce FCF by the percentage ownership of minority interests (70%, in this case), or by the absolute amount of earnings that went to the minority owners (about a billion dollars, in this case)? Either way, though, free cash flow here is either about $300 million (still cheap) or essentially nothing (rather less cheap).

    Similarly, the P/NAV should be something like 0.375 rather than 0.1, since only $4 billion of the company's equity is attributable to equity shareholders, versus a market cap of $1.5 billion. That's still cheap, but rather less so than 0.1.

    1. Having thought about it a little more, I don't think translating minority interests from earnings to free cash flow is as easy as either of the methods I just mentioned. For example, if minority interests own almost all of your FCF producing assets, leaving equity shareholders with only non-profitable assets, then FCF will logically be close to nothing for equity shareholders. In the opposite situation, then almost all of the FCF stated on the company's cash flow statement would go to equity shareholders.

      Given that minority interests seem to own almost all of the earnings-producing assets at Vedanta, it seems likely that they own almost all of the earnings too. In that context, I'm skeptical that shareholders get much in free cash flow in this situation.

    2. Charles,
      You are of course right on the P/NAV point. But given that the stock has bounced 50 odd per cent since I bought it, I will forgive myself this oversight on my part.


