Rating Rationale

Strengths
* Diversified business risk profile
Vedanta's businesses span across zinc, lead, silver, aluminium, oil and gas, iron ore, power, and steel. The group is among the largest producers in all these segments, commanding a strong market position in India. A well-diversified business profile cushions it from commodity-specific cyclicality and risks.

* Low-cost position of key businesses
The domestic zinc, lead, and silver businesses are supported by low cost of production, large reserves, and continued resource addition. Earnings in zinc business is expected to benefit in current fiscal from higher share of silver production along with improved silver realisation. Profitability in the oil and gas business is aided by low operating cost and a business model that ensures capex recovery. Cash flow in this business will benefit from capex-led improvement in volume over the medium term. Notably, the government has been providing only short-term extensions for continuity of operations for the Rajasthan block. Further, additional claim of dues related to disallowed costs, raised by Directorate General of Hydrocarbons (DGH), is under arbitration. While CRISIL understands from the company that the final PSC would be approved by the Government, with effect from 15 May 2020, this would be a key monitorable.

* Strong volume growth expected, over the medium term, with capital allocation towards value-accretive zinc and oil and gas businesses
Production in the zinc and oil and gas businesses have improved, albeit slower than expected. Increased mined metal capacity of 1.2 million tonne per annum (mtpa) in domestic zinc along with ramp up of Gamsberg's operations in zinc international should support improvement in volumes for zinc business. Further, expected addition of new wells and surface facilities during second half of current fiscal should result in increase in volumes for oil & gas business. Strong volume growth over the medium term should make the overall business risk profile more resilient.

* Improved operating profitability in the aluminium business
Lack of integrated operations, with 25% domestic bauxite linkage and less than 50% owned alumina production, had impacted profitability during past fiscals. However, improved linkage coal sourcing (increased from 45% in fiscal 2018 to over 70% since the fourth quarter of fiscal 2020), reduced coal prices, and lower imported alumina cost, have led to improved cost efficiency for the aluminium business (EBITDA of more than USD 300 per tonne since fourth quarter of fiscal 2020). Furthermore, cost efficiencies should further improve over the medium term, because of the following factors ' increased share of captive and linkage coal supported by access to Jamkhani coal mine in Odisha and focus on increasing the share of local bauxite and alumina sourcing. Refinery capacity expansion to 4 mtpa (an increase by 100%) over the next two fiscals, and the Supreme Court's judgement allowing Vedanta to bid for National Aluminium Company Ltd's surplus alumina should also support the operating efficiencies of the business.

Weaknesses
* Large dividend pay-out with significant capex, resulting in high leverage
Continued assistance through dividend payout to the parent, VRL, to support the latter's debt has led to significant cash leakage to minority shareholders. Given the increased refinancing risk for VRL, Vedanta may witness higher-than-expected dividend in current fiscal. Additionally, annual capex of Rs 6,000-7,000 crore (reduced from Rs 10,000 crore) is expected in fiscals 2021. Thereby, net leverage, which was high at 3.8 times as on March 31, 2020, is expected to remain elevated at over 3.2 times by end of fiscal 2021. Expected improvement in profitability and lower dividend payout is expected to support reduction in net leverage over the medium term. However, profitability is susceptible to volatility in prices of metals and oil and gas and thereby, any large capex, acquisition or higher-than-expected cash outflow to support VRL remains a key monitorable.

* Exposure to changes in regulations
The businesses are vulnerable to regulatory risks. Since May 2018, the copper smelting plant at Thoothukkudi, Tamil Nadu, has been closed following a directive from the Tamil Nadu Pollution Control Board. Suspension of iron ore mining operations in Goa, currently, and in Karnataka in the past, have had an adverse impact on the iron ore business. Further, any adverse outcome of the currently disputed conditional approval of profit sharing contract could reduce profit margins for oil and gas business.