Stock Recommendation | Vedanta - BUY - Target price : 330

Changes in our estimates
Exhibit 8 highlights key changes in our estimates, here's a summary:
▶ We cut our aluminum EBITDA/ton estimate to US$220/ton, US$360/ton and US$390/ton for FY2019E, FY2020E and FY2021E from US$220/ton, US$410/ton and US$430/ton, respectively. The lower EBITDA/ton reflects higher alumina prices-though we expect alumina prices to decline from >25% in FY2019E to ~19% in FY2020-21E. We highlight that a large number of non-integrated aluminum smelters globally will be incurring cash losses at API index of >20%.
▶ We incorporate our revised estimates of Hindustan Zinc in Vedanta model-see our note dated October 23, 2018.
▶ In Zinc International, we have adjusted our volumes, costs for FY2019-21E.
▶ We have factored in (1) lower O&G volumes versus earlier assumptions given indicated delay in commencement of growth projects, and (2) higher crude prices.
These changes result in 3-6% cuts in our EBITDA estimates to Rs273 bn, Rs331 bn and Rs341 bn for FY2019E, FY2020E and FY2021E. Our EPS estimate is cut by 11-18% for FY2019-20E due to higher interest costs, depreciation charges beside lower EBITDA. We estimate EPS of Rs22.5, Rs33.1 and Rs34.1 for FY2019E, FY2020E and FY2021E.

Other highlights of 2QFY19 results, earnings call
The performance across businesses was as follows:
▶ Oil & gas-lower-than-expected contribution due to decline in volumes. Oil and gas revenues and EBITDA increased 8-9% qoq to Rs34.8 bn and Rs20.3 bn respectively, albeit 6-7% below our estimates led by surprising 5% qoq decline in net production volumes to 118.7 kb/d, led by lower production from Rajasthan block; crude realizations were higher at US$69.5/bbl versus US$67.2/bbl in the previous quarter, at a lower discount of US$5.7/bbl to Dated Brent crude. Oil and gas EBIT increased to Rs14.3 bn in 2QFY19 from Rs12.8 bn in the previous quarter. The management indicated delays in award of projects in Rajasthan block, while sharply cutting its gross production guidance to 200-220 kboe/d in 2HFY19 versus earlier guidance of 220-250 kboe/d in FY2019.
The government has granted ten-year extension for the PSC of Rajasthan block (RJ-ON- 90/1) effective from May 2020 onwards, under the existing policy framework, which mandates an increase in the government's share of profit petroleum by 10%; the matter remains sub-judice in the court, however, the company has sought the extension without any change in fiscal terms.
▶ Decline in aluminum earnings due to cost increases, lower prices. VEDL's aluminum EBITDA declined 68% qoq to Rs4 bn (-13% yoy, KIE: Rs6 bn) due to an increase in production costs which increased by 9% qoq to Rs141,300/ton due to higher alumina, power costs. Aluminum volumes increased 6% qoq to 495,000 tons (+29% yoy) led by ramp-up of Jharsuguda II smelter. EBITDA/ton declined to US$144/ton (from US$424/ton in 1QFY19) due to a combination of increased costs and lower prices. Management expects FY2019E production at 2 mn tons and costs at U$1,950-2,000/ton (US$1,978/ton in 1HFY19).
▶ Zinc International-lower volumes, higher costs. EBITDA at Zinc International declined 81% qoq to Rs160 mn (-96% yoy) due to (1) lower production volumes of 28,000 tons (-35% yoy, +12% qoq) and increase in production costs to US$2,428/ton (+65% yoy, +3% qoq). The management expects an improvement in 2HFY19 with full year production of 150 kt (53 kt in 1HFY19) and production cost at US$1,850-1,950/ton (US$2,393/ton in 1HFY19). Gamsberg production is not yet reflected in financials- management expects FY2019E production from Gamsberg at 75 kt and production costs at US$800-1,000/ton. The trial run of concentrator at this project commenced in September 2018. Management expects FY2020E production from Gamsberg at 250 kt.
▶ Hindustan Zinc-EBITDA declines 14% qoq. Hindustan Zinc's EBITDA declined 14% qoq to Rs23.3 bn (-23% yoy). The sequential decline in earnings was due to (1) 6% qoq decline in zinc sales volumes to 160,000 tons (-17% yoy), and (2) lower zinc realizations (- 13% qoq), lead realizations (-7% qoq) and silver realizations (-4% qoq). The company's mined metal volumes increased 9% qoq to 232,000 tons (+6% yoy) led by ramp-up of underground mines. Lower refined zinc output (162,000 tons, -6% qoq, -16% yoy) was due to a mismatch in zinc mined metal availability as mined production ramped up towards the latter half of the quarter. Lead production increased 17% qoq to 49,000 tons while silver production increased 25% qoq to 172 tons-increase in silver production was led by higher lead metal processing and increased ore production from SK mines (which has rich silver ore grades).
Production costs increased 14% yoy to Rs72,449/ton (US$1,034/ton, +5% yoy) due to a combination of lower volumes, high fuel costs and wage costs.
▶ Power-weak earnings. Power EBITDA declined by 11% qoq to Rs3.8 bn (+3% yoy) due to (1) lower generation at Balco (600 MW) and Jharsuguda (600 MW) power plant, and (2) increase in generation costs. The lower generation, higher cost was largely due to limited coal availability. Plant availability at Talwandi Sabo improved to 94% in 2QFY19 from 91% in 1QFY19.
▶ Iron-ore (EBITDA at Rs980 mn). Iron-ore EBITDA declined 40% qoq to Rs980 mn due to lower volumes. Sales volumes declined to 0.4 mn tons (1.4 mn tons in 1QFY19, 0.7 mn tons in 2QFY18) due to closure of Goa mining operations and monsoons. Electrosteel reported EBITDA of Rs1.7 bn (Rs2.1 bn in 1QFY19) due to lower steel prices.
Other points
▶ Net-debt and FCF. VEDL's net-debt declined to Rs264 bn in September 2018 from Rs299 bn in June 30, 2018 (this excludes buyer's credit of US$700-750 mn). The company earned operating cash flows of Rs38.9 bn during the quarter while cash flows were also aided by working capital release of Rs23 bn. The capex for the quarter was Rs25.5 bn.
VEDL expects FY2019E capex at US$1.5 bn largely towards oil & gas and zinc operations. The capex in FY2020E can increase to US$1.8 bn due to US$600 mn expected investment for Electrosteel Steels expansion and Lajigarh refinery expansion to 4 mtpa.
▶ The company declared interim dividend of Rs17/share. The record date for payment will be November 10, 2018.

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