Sesa Sterlite (SSLT, Financial), a diversified natural resources company, which is currently trading at $12.33 per share, is a value buy. This article discusses the reasons to be bullish on the stock and expecting minimal downside and significant upside from current levels.
If a one year chart for Sesa Sterlite is considered, the stock was trading at $21.19 on June 5, 2014. The single factor that triggered a 42% correction in the stock is the company’s exposure to oil and gas assets through its 59.9% stake in Cairn India. With oil prices falling steeply during the period under discussion, Sesa Sterlite slumped.
However, with oil prices finding some bottom in place and hovering around current levels, I believe that Sesa Sterlite has also bottomed out. Further, with Cairn India reducing its 2015-16 capital expenditure plan due to lower oil prices, Sesa Sterlite has also discounted the impact of lower investments on the company’s EBITDA and cash flow.
Considering these factors, the stock is very inexpensive at an EV/EBITDA valuation of 2.8. Freeport-McMoRan (FCX, Financial), another diversified natural resources company with oil and gas assets is currently trading at an EV/EBITDA of 4.66. On a relative basis, Sesa Sterlite has lower leverage as compared to Freeport-McMoRan and the company also has higher growth prospects with its core operations in India. Therefore, the valuation is really attractive and the stock deserves consideration and gradual accumulation at these levels.
For the third quarter of 2015 (year ending March 2015), Sesa Sterlite’s EBITDA mix was 34% from oil and gas assets and 40% from zinc assets. I wanted to mention this point as the EBITDA contribution from oil and gas assets will be meaningfully higher when oil prices recover. If the company’s EBITDA trend for FY14 is observed, the oil and gas assets contributed to nearly 55% of the EBITDA with zinc contributing to 27% of the EBITDA.
The purpose of this data is to show that oil and gas assets are a key cash flow driver for the company and therefore I recommend gradual accumulation of the stock in the coming months. With oil prices unlikely to move significantly higher in 2015, Sesa Sterlite upside will also be capped, but the stock is certainly at valuations that are mouth-watering. As oil prices recover, the real value of the stock will unfold.
As I mentioned earlier in the article, Sesa Sterlite is not significant leveraged. This is a big positive factor in difficult times for the natural resources industry. As of December 2014, Sesa Sterlite had a consolidated debt of $12.5 billion and a cash position (including liquid investments) of $7.4 billion. A net debt of $5.1 billion (net debt to EBITDA of 1.3) is therefore not a matter of concern and it gives Sesa Sterlite high financial flexibility.
Besides huge investment planned in the oil and gas assets, Sesa Sterlite has also been making investments in the Indian and international zinc division of the company. This is important from a company’s balanced growth perspective as the zinc division is also a high EBITDA contributor. With India’s per capital consumption of natural resources well below the global average, Sesa Sterlite is well positioned to benefit as India’s GDP growth in expected to trend higher in the coming years. I must also add here that oil and gas resources in India have still not been fully exploited and there will be significant asset growth for Sesa Sterlite within the country.
In conclusion, Sesa Sterlite is certainly one stock to consider for the long-term portfolio. The company has got an excellent oil and gas asset that have a high reserve life and strong cash flow potential. Once oil prices recover, Sesa Sterlite can surge significantly higher and be a portfolio catalyst.
