Will Vedanta's Demerger Plan Unlock Value? Parent VRL's Debt Is Biggest Elephant In The Room!

Billionaire Anil Agarwal plans to demerge its metal and mining maker Vedant's business units into independent 'pure play' companies. Ultimately, Vedanta and its business will be separated into six listed companies by FY25. The main aim is to unlock value and attract big-ticket investment into the expansion and growth of each of the businesses. This has led to a rapid rally in Vedanta shares by as much as 5% on Tuesday.

But analysts are split into mixed opinions when it comes to Vedanta's demerger plan, however, they agree on one thing and that the move is not enough to solve the parent company Vedanta Resources debt problems.

On Tuesday, Vedanta shares gained by 5.07% with an intraday high of Rs 233.80 apiece on BSE. On the previous day, the stock stood at Rs 222.50 apiece.

The Demerger Plan:

At present, Vedanta has a unique portfolio of assets among Indian and global companies with metals and minerals - zinc, silver, lead, aluminium, chromium, copper, nickel; oil and gas; a traditional ferrous vertical including iron ore and steel; and power, including coal and renewable energy; and is now foraying into manufacturing of semiconductors and display glass.

As per the regulatory filing, once demerged, each independent entity will have greater freedom to grow to its potential and true value via independent management, capital allocation and niche strategies for growth. It will also give global and Indian investors the potential to invest in their preferred vertical, broadening the investor base for Vedanta assets.

Hence, Vedanta's board approved a pure-play, asset-owner business model that will ultimately result in six separate listed companies, such as Vedanta Aluminium, Vedanta Oil & Gas, Vedanta Power, Vedanta Steel and Ferrous Materials, Vedanta Base Metals, and Vedanta Limited.

The demerger will take place in the next 12-15 months, in a simple vertical split, for every 1 share of Vedanta Limited, the shareholders will additionally receive 1 share of each of the 5 newly listed companies.

Will Vedanta's Demerger Unlock Value?

In its research note, Nuvama said, that Vedanta's strategy to demerge its businesses as a step in the right direction. That said, it is cognisant that value unlocking will take at least a year. The brokerage mentioned that Vedanta's management expects this process to be completed in 12-15 months (i.e. by CY24-end).

Nuvama's note added, "We thus believe VRL would be able to refinance its debt (helping to increase duration), which will allay fears of a default. VEDL needs two years to set its house in order. With growth expected to come from its aluminium business from FY25 (post-commissioning of its alumina, aluminium and coal mines), it will have cash flows, which can help in servicing debt. Moreover, the company will have an opportunity to either sell part of one of its businesses or raise money by diluting its equity."

But brokerage Kotak Institutional Equities has a different opinion. In its research note, this brokerage said, "The demerger, by itself, is unlikely to unlock any value, in our view."

Kotak believes that a separate listing of different businesses would reduce the fungibility of cash flows across businesses and increase the volatility of cash flows. This could make lenders' approval challenging, given the elevated debt levels, with net debt/EBITDA at +4X over FY2024-26E for VEDL (ex-HZL).

Also, Kotak pointed out that in the past, VEDL underwent a tedious process of merging various listed entities, with the merger of (1) Sesa Goa and Sterlite in 2012 and (2) SesaSterlite and Cairn India in 2017. VEDL's decision to demerge and separately list different business units to unlock value contradicts the rationale for past corporate actions.

The Biggest Elephant In The Room For Vedanta:

Vedanta's parent company Vedanta Resources debt problems and funding gap continue to be the key overhang.

According to Nuvama, the demerger plan does not address parentco VRL's debt issue. It said, "We understand VRL has a debt obligation of $4.2 billion-$1.3 billion in H2FY24 and USD2.9bn in FY25. As this demerger does not improve VEDL's credit profile, the situation remains the same for VRL-to refinance the debt. VEDL's cash flows are not sufficient to upstream the dividend to VRL unless it assumes debt on its books."

Along similar lines, Kotak's note said, "VRL's high leverage and funding gap of US$3 bn in FY2025E are key areas of concern and overhang for the company. We believe the hefty dividends by VEDL/HZ, similar to that in FY2022-23, are no longer sustainable. VRL can deleverage only through the divestment of the stake in VEDL or individual businesses. The demerger could make a partial divestment in different businesses easier, which would help VRL in deleveraging."

Recently, rating agencies like Moody's Investor Services and S&P Global downgraded their ratings on VRL to Caa2 and CCC due to elevated risks in debt restructuring.

Buy, Sell Or Hold Vedanta Shares?

Nuvama has upgraded its rating on Vedanta to Hold from an earlier Reduce.

It said, "We see limited downside from current levels, and maintain the TP at Rs 249. We value VEDL at 4.5x FY25E EV/EBITDA ex-HZ (Rs 87) and add the value of VEDL's share in HZ (Rs 162, valuing at 6x EV/EBITDA). All in all, we are upgrade VEDL to 'HOLD' (from 'REDUCE')."

On the other hand, Kotak said, "Maintain SELL, with an unchanged FV of Rs200, given the unfavorable risk-reward."

Meanwhile, Phillip Capital is Neutral On Vedanta shares for a target price of Rs 290 per share.

Disclaimer

The recommendations made above are by market analysts and are not advised by either the author nor Greynium Information Technologies. The author, nor the brokerage firm nor Greynium would be liable for any losses caused as a result of decisions based on this write-up. Goodreturns.in advises users to consult with certified experts before making any investment decision.