Sesa Sterlite (UNKNOWN:SSLT.DL) surged by 12.5% on Friday as the world closely watched the developments around the Indian elections. The rally is certainly not a one-off reaction to the positive election outcome, however. This article discusses the key reasons to remain bullish on this stock, which is likely to be a long-term value creator and is a solid addition to your portfolio.
Enormous industry potential
India's per capita consumption of commodities is significantly low as compared to the world and China.
With the new government promising development, urbanization and a swelling middle class will drive the per capita consumption of commodities. Being the market leader, Sesa Sterlite is best positioned to capitalize on the growth opportunity. The rally on Friday underscores the point that market participants are bullish on the company's growth prospects.
Strong company fundamentals
Sesa Sterlite has very strong fundamentals, which will help the company invest in assets and grow significantly. For the 9M FY2014, Sesa Sterlite had a cash and liquid investments position of $8 billion, undrawn lines of credit of $1.2 billion, and a free cash flow of $2.5 billion.
With the company planning to invest $4.3 billion in capital expenditure up to FY2016, a strong cash position ensures capital spending without taking on more debt.
Even in terms of debt maturity, Sesa Sterlite is well placed with $1.6 billion debt maturing in FY2015 and only $0.8 billion each in FY2016 and FY2017, respectively.
Also, with a healthy debt-to-EBITDA ratio of 1.3 and a net gearing ratio of 25%, Sesa Sterlite has the scope to leverage (if needed) for growth or acquisition.
Oil and gas assets are the game-changer
While Sesa Sterlite will continue to grow its business in the industrial commodities segment, one of the biggest changes for the company will be its oil and gas assets. The reasons are as follows:
Sesa Sterlite owns 58.9% of Cairn India, which is also the fastest growing Asian E&P company according to Platts 2011. Cairn India's Rajasthan block is the largest onshore discovery in India in the last 20 years and has an estimated 7.3 billion barrels of oil equivalent in place with a basin potential to support a production rate of 300,000 barrels of oil per day.
As per the company's plans, the capital expenditure in the oil and gas asset will be $2.5 billion over the next two years. This will translate into higher production and revenue growth.
The oil and gas segment has an EBITDA margin of 75% as compared to the company's overall EBITDA margin of 48%.
Higher revenue contribution from the oil and gas segment will boost overall EBITDA margin.
Considering these positive factors, Sesa Sterlite is likely to see robust revenue growth and EBITDA margin expansion in the foreseeable future.
Attractive valuation compared to peers
Sesa Sterlite is undervalued on key valuation metrics as compared to peers. This undervaluation backs my point that the current rally is likely to be sustained.
I have considered Freeport-McMoRan Copper & Gold (NYSE:FCX) a peer as it is a globally diversified natural resources company. Southern Copper Corp. (NYSE:SCCO) also has global presence with operations in copper, zinc, silver, gold, coal, and coke.
There are two key differences between the above peers and Sesa Sterlite, making the company's valuation even more attractive.
First, Sesa Sterlite has an India focus, where the growth potential is immense as compared to the other peers focusing on China, where growth has been sluggish in the recent past. China's sluggish growth is already having an impact on Freeport and Southern Copper as earnings growth for FY2014 is likely to be negative 7.2% and 8.3% respectively.
Second, Sesa Sterlite has a high-EBITDA-margin oil and gas business, which is absent for Freeport and Southern Copper. Clearly, Sesa Sterlite is a winner in terms of valuations.
Sesa Sterlite is currently at an inflection point in terms of growth. The new government, whose leader has proved to be investment-friendly at a state level, is likely to open up new growth opportunities for the company. With a high level of capital expenditure lined up for the next two years, Sesa Sterlite is attractive at current valuations with a medium to long-term investment horizon.
Faisal Humayun has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.