January 20, 2015

Mumbai

Sesa Sterlite Limited

Rating outlook revised to 'Negative'; ratings reaffirmed

(Refer to Annexure 1 for details on facilities)

CRISIL has revised its rating outlook on the debt instruments and bank facilities of Sesa Sterlite Ltd (Sesa Sterlite; a part of the Vedanta group) to ‘Negative’ from ‘Stable’ while reaffirming its ratings at ‘CRISIL AA+/CRISIL A1+’.

The outlook revision reflects CRISIL’s belief that Sesa Sterlite’s consolidated cash flows are likely to be lower than earlier expectations driven by a combination of lower oil prices, delayed ramping up of aluminium smelting and power capacities, and lower volumes from the iron ore business. Consequently, Sesa Sterlite’s net debt (includes around USD4.8 billion of Vedanta Resources Plc's [Vedanta Resources; rated 'BB/Watch Neg' by Standard & Poor's] debt) to earnings before interest, tax, depreciation, and amortisation (EBITDA) is likely to deteriorate to around 2.5 times in 2014-15 (refers to financial year, April 1 to March 31) and may take longer than expected to correct. This is contrary to CRISIL’s earlier expectations that net debt/EBIDTA will witness improvement to less than 2 times in 2014-15 from 2.3 times in 2013-14. Moderation in the cash flows from the oil and gas, iron ore, and aluminium businesses may be partially offset by the higher volumes and prices in the zinc business, coupled with the healthy conversion margins in the copper business. In addition, CRISIL believes that Sesa Sterlite’s consolidated net debt may not increase substantially owing to completion of a major proportion of capital expenditure (capex) in the aluminium and power businesses.

With oil prices plummeting over the last few months, cash flows from Sesa Sterlite’s oil and gas business–a key contributor to company’s consolidated profits is expected to weaken going forward. Although Sesa Sterlite can moderate its capex in the oil and gas business due to decline in oil prices, free cash flows from the oil and gas business will be lower than earlier expectations. CRISIL believes that oil prices and its impact on Sesa Sterlite’s cash flows from the oil and gas business will remain a key rating sensitivity factor.

The outlook revision also factors in the delay in the commissioning and ramp up of smelting (Sesa Sterlite 1.25 kilo tonnes per annum (ktpa) and Bharat Aluminium Company Ltd’s [Balco] 325 ktpa) and power capacities (2400 MW in Sesa Sterlite, 1200 MW in Balco, and 1980 MW in Talwandi Sabo Power Ltd [TSPL; rated ‘CRISIL AA+ (SO)/Negative/CRISIL A1+ (SO)’]). As on September 30, 2014, Sesa Sterlite had incurred a capex of about Rs.490 billion for the above-mentioned projects. However, due to the lack of regulatory approvals, raw material linkages, and other project-execution issues, the ramp up has been slower than expected. In January 2015, Balco received the approval from the Chhattisgarh government to start the 1200-MW power plant. All the four units of the power plant are expected to be operational by March 2016. The time taken to ramp up the aluminium and power capacities and the resultant cash flows are key rating sensitivity factors.

Furthermore, continuation of mining ban in Goa has resulted in lower volumes and cash flows from the iron ore business. Although the mining ban was lifted by the Supreme Court in 2014, CRISIL believes that the mining operations are expected to start only in 2015-16, post receipt of necessary approvals. CRISIL believes that, even after the regulatory clearances, the cash flows from the iron ore business will continue to be moderate given the low iron ore prices and high export duty structure.

The ratings continue to reflect Sesa Sterlite's diversified business risk profile; its cost leadership in zinc, and the oil and gas segments; and its healthy financial risk profile. In the iron ore, copper, and zinc businesses, it is among the largest and lowest-cost producers commanding a strong market position. However, in the aluminium business, Sesa Sterlite’s cost of production continues to be in the second quartile due to lack of raw material linkages. CRISIL believes that Sesa Sterlite’s aluminium business has the potential to move into the first quartile if the company secures its own bauxite and coal sources. A diversified business risk profile with cost leadership across businesses partially insulates Sesa Sterlite from cyclicality and regulatory risks inherent in its businesses.

CRISIL also continues to factor in the financial flexibility that Sesa Sterlite derives from the high market value of its investments in the subsidiaries. The combined market value of the company’s investments in Hindustan Zinc Ltd (HZL) and Cairn India Ltd (Cairn India) was around Rs.700 billion as on January 15, 2014. However, structural subordination arising from fragmented shareholding and separation of debt from the cash flows and liquidity constrain the financial risk profile of Sesa Sterlite. A major proportion of Sesa Sterlite’s debt resides at the standalone level whereas a significant proportion of cash flow generation and cash and cash equivalents reside in HZL and Cairn India. These subsidiaries have significant minority shareholders, which limits Sesa Sterlite’s ability to access their liquidity. Limited access to liquidity is partially mitigated by Cairn India’s dividend payout policy of a minimum 20 per cent and dividend from HZL. However, CRISIL believes that Sesa Sterlite has strong intent and ability to buy the Government of India's (GoI's) minority stake in HZL and Balco.

For arriving at the ratings, CRISIL has combined the business and financial risk profiles of Sesa Sterlite, Cairn India, HZL, zinc business in Namibia, South Africa, and Ireland (termed as Zinc International), Balco, and Copper Mines of Tasmania Pty Ltd (CMT). This is because these entities are Sesa Sterlite's subsidiaries, operate under a common management team, and have operational and financial linkages. As part of the analytical approach for Sesa Sterlite, CRISIL has also included Vedanta Resources’ debt of around USD4.8 billion (excluding ICD of USD2.7 billion extended to Sesa Sterlite’s 100 per cent subsidiary Twin Star Mauritius Holdings Ltd) as on September 30, 2014, in the capital structure analysis of Sesa Sterlite as a significant portion of this debt could be serviced from the cash flows of Sesa Sterlite.

Outlook: Negative

The ‘Negative’ outlook reflects the likelihood of Sesa Sterlite’s cash flows being lower than expected due to decline in oil prices, delayed ramp up of the aluminium and power capacities, and lower volumes from the iron ore business. The rating may be downgraded if the consolidated cash flows do not lead to significant improvement in Sesa Sterlite’s net debt/EBIDTA. Conversely, the outlook may be revised to ‘Stable’ if the consolidated cash flows are according to CRISIL expectations leading to substantial improvement in Sesa Sterlite’s net debt/EBIDTA, or if Sesa Sterlite reduces its debt significantly.

About the Group

The Vedanta group is majority-owned by Vedanta Resources, a metal, mining, power, and oil-and-gas company, listed on the London Stock Exchange.

Vedanta Resources held 64.3 per cent stake in Sesa Sterlite as on December 31, 2014. The Vedanta group's copper, iron ore, and power divisions (2400-megawatt [MW] and 1215-MW captive power plants for the aluminium business), and its aluminium assets in Jharsuguda and Lanjigarh (Odisha) reside in Sesa Sterlite. The group also carries out its aluminium operations through Balco. A part of the power business (1980 MW) is also conducted through its wholly owned subsidiary, TSPL. The group operates its oil and gas business through Cairn India and the zinc business in India through HZL. The Vedanta group also has copper mines in Australia held by CMT; copper business comprises mining and smelting operations in Zambia, and zinc assets in South Africa, Namibia, and Ireland.

For 2013-14, Sesa Sterlite reported net profit of Rs.103.4 billion on operating income of Rs.661.5 billion. For the half year ended September 30, 2014, Sesa Sterlite reported net profit of Rs.45.1 billion on net sales of Rs.366.9 billion.

Annexure 1 - Details of various bank facilities

*** Interchangeable with packing credit in foreign currency (PCFC) to the extent of Rs.0.12 billion and with buyer’s credit, letter of undertaking, and bank guarantee to the extent of Rs.0.60 billion.

^Interchangeable with letter of undertaking to the extent of Rs.1.5 billion.

@ Facility contracted for capital expenditure to the extent of Rs.1 billion; interchangeable with usance letter of credit and buyer's credit to the extent of Rs.4 billion, with sub-limits of Rs.2 billion of performance bank guarantee, Rs.0.5 billion for financial bank guarantee, Rs.2.5 billion for revolving short-term loan, Rs.2.5 billion for working capital demand loan/ cash credit, Rs.2.5 billion for sale/ purchase bill/ invoice discounting, and interchangeable with letter of undertaking to the extent of Rs.10 billion.

# Interchangeable with buyer's credit and usance letter of credit to the extent of Rs.1.0 billion; interchangeable with buyer’s credit, letter of undertaking and bank guarantee to the extent of Rs.1.15 billion; and interchangeable with bank guarantee, and letter of undertaking for buyer’s credit to the extent of Rs.103 billion

$ Fully interchangeable with cash credit, PCFC, letter of credit, bank guarantee, and letter of undertaking for buyer’s credit.

% Fully interchangeable with cash credit, PCFC, letter of credit, bank guarantee, and letter of undertaking for buyer’s credit.