Commodity Czar

Anil Agarwal has seen his fortunes change with an upswing in commodity prices.

Photo: Vivan Mehra Photo: Vivan Mehra

Nearly 1000 metres deep in the womb of mother earth, some 80-odd kms from Udaipur in Rajasthan, a stream of monstrous 60 tonne trucks haul zinc ore over steep ramps. The deafening roar of their 760 HP engines inside Hindustan Zinc's Sindesar-Khurd (SK) Mine is a cochlea-numbing experience. Mine chief Sanjay Kumar Sharma is hollering away on the wireless. He doesn't have a choice as the wireless buzzes with a heady combination of Peruvian, Brazilian, Rajasthani, Punjabi, Hindi and heavily accented English from truck operators and their supervisors. Consequently, misunderstanding is not uncommon and nor is the scenario of this orderly movement of heavy duty trucks giving way to chaos. A wrong instruction could cause traffic jams lasting several hours on the one-way ramps. When they happen, Sharma needs to resolve the confusion fast-real fast. Delay in ore supply leads to production loss at a time when global zinc prices are on a tear. It also goes counter to group chairman Anil Agarwal's mandate to ramp up zinc production to cash in on the uptrend in prices - it will earn more per tonne and costs will be spread over a higher base.

For nearly a decade, zinc remained an under-invested sector globally. But in a span of just two years - with some large mines in Australia and Ireland exhausting their resources and some in China shutting down due to environmental concerns - global zinc surplus turned to shortage, global inventory hit an 18 year low and world zinc prices nearly doubled from $1,600 a tonne to just over $3,000 per tonne. As an integrated player with a production cost of barely $800 per tonne, suddenly Vedanta is raking profits in zinc.

Zinc is to Vedanta group today what oil (Cairn India) was until 2014-a huge cash cow, while other businesses aluminium, zinc and copper were just above the water. But the tide has turned in the commodity cycle and Lady Luck is smiling on each one of Anil Agarwal's four key businesses. After the political brouhaha over its plan to mine raw material bauxite from Odisha's Niyamgiri hills, Vedanta's aluminium business was in the red because a vast majority of its bauxite and alumina (intermediate for aluminium) had to be imported to keep the Lanjigarh refinery running. Global aluminium prices have, since then, turned around from $1,300-1,400 per tonne to nearly $1,900 per tonne, not only taking it out of the danger zone (Vedanta breaks even at a shade under $1,400) but bringing it into the black.

Meanwhile, crude oil price, which had hit a trough of $27.88 per barrel in January 2016, has nearly doubled to about $60 per barrel since OPEC introduced production cuts, bumping up Vedanta's oil business-Cairn is marginally profitable at $40 per barrel. And the group's copper business in India and Zambia has never had a better run than now, netting a profit of $5,000 per tonne of additional copper produced. Even Goa-based iron ore, a smaller business comparatively, is seeing signs of revival with the government re-opening mining and exports.


Mention the word 'luck' to Agarwal and he shoots back: "I believe you have to take the first step. Luck follows." How long will this run last? "Humko to lamba hi lagta hai (I think it's going to last fairly long). I don't see it bearish for the next 5-7 years. I am bullish on oil also. Renewables will not make a difference. There is no new discovery," explains Agarwal. "I always tell my people that everybody is going to die but you must die last. Cost should be that low and the product quality should be that good. We are moving forward with the determination of the last man standing," says Agarwal, in an uncharacteristic reference to the days gone by rather than the golden phase he finds himself in.

In fiscal 2017, India business holding company Vedanta Ltd. recorded a net profit of Rs9,873 crore on revenues of Rs76,171 crore thanks to an uptick in global commodity prices. That's a huge shift from a loss of Rs17,862 crore in fiscal 2016 on revenues of Rs67,993 crore. Its group market cap in India shot up Rs1.1 lakh crore in March 2016 to Rs2.24 lakh crore in March 2017. With capacity ramp-ups in zinc, aluminium, copper, oil and power generation set to reflect on the top line and bottom line in fiscal 2018, Vedanta is eyeing getting close to its potential consolidated EBITDA of $6 billion as against $3.2 billion in fiscal 2017 and $2.3 billion in fiscal 2016. "Two years ago, 40 per cent of my invested asset base was not earning. Today, 90 per cent is earning, generating excellent bottomline. The capability of our bottomline is $6 billion, the question is, which quarter do you start hitting that run rate? At that EBITDA you can generate excellent cash," says group CFO G. Arun Kumar. With the post-merger combined marketcap of Vedanta-Cairn nearing its historical peak, the stock market too appears to be giving it a thumbs-up.

"Aluminum is the big story in cash flow terms and results because the capital expenditure is already done. As we ramp up, cost comes down (due to) a simple mathematical effect of fixed cost getting divided by larger volumes," says Samir Cairae, CEO, Metals (India), Vedanta Resources. "As we go from one to three million, I reduce costs by 30 per cent. That's why this a big swing for Vedanta Group. Of course, we have to ensure it happens.,"

But look closer and you will find Vedanta still trades at a multiple of 3.9-4.5x of EBITDA versus global peers at 6-7x. "At CMP (current market price), the stock is trading at 3.9x FY19E EBITDA, at a discount to global peers, which are trading at 6-7x," says an Edelweiss research report on Vedanta on July 25.

Why are global miners BHP and Rio Tinto higher? "It all boils down to scale, size and global reach. And probably some best practices to learn from. That's what our intention is," says G Arun Kumar, group CFO.


Compared to global peers, Vedanta's reserves base as a percentage of production is lower because of uncertainty over bauxite reserves in aluminium and in oil (the 20 year lease for Cairn in Barmer ends in 2020). However, zinc reserves would last 25 years at current rate of production and copper over 35 years.

Two, small and marginal investors didn't appreciate the Cairn-Vedanta merger where Cairn's reserves were leveraged to fund Vedanta's other businesses. "It's the corporate image they need to work on. Investors haven't had a good memory. NGOs have accentuated this," says a Mumbai-based equity analyst. "Minority investors didn't like the fact that $1 billion of inter-corporate deposit was taken from Cairn. Earlier, Sesa Goa's cash was used to buyCairn India." Besides, there's a conglomerate discount.

Agarwal, however, likens it to racism, narrating an anecdote: When my daughter was 8 years old and she went to England I said I will get her admitted to the best school. Worlingham was one of the best schools. There she was the only Indian. She was very excited that she's learning horse riding, swimming, etc. In 10 days she came home with a long face. She was subjected to racism. She wasn't allowed to sit on the bench, they didn't give her horse riding, swimming. Nobody was talking to her. She said take me home. I told her that we are in a different country. Unless you do 25 per cent better than them you'll never get a position. She listened. She worked hard. Everybody became her friends.

"I'm in the same state. How will peers agree? BHP and Exxon will not consider me equal. I tell my people that you are on the radar of NGOs, government, stock markets, investors. We are coming out of it. This is a path we are going through but when you see the result, what kind of product we are making, what kind of return we give, how in a desert we are producing oil. Once they see this, it will die out,"says Agarwal.

In October, Agarwal's holding company Volcan invested an additional ?2 billion to become the largest stakeholder - a 21 per cent stake - in mining major Anglo American, the owner of De Beers. Founded by the South Africa's Oppenheimer family nearly a century ago, Anglo American is into iron-ore, diamond, copper and gold and ranks among the world's five largest mining groups, shoulder to shoulder with Rio Tinto, BHP, Glencore and Vale.

So how can Agarwal-who began as a scrap dealer in Patna-ensure Vedanta doesn't lose sight of his dream to make it yet another BHP Billiton or Rio Tinto?

With the Niyamgiri bauxite reserves embroiled in a political tangle, including a public attack by Rahul Gandhi during the 2014 elections, and its Chhattisgarh mine unable to meet the entire requirement of the Lanjigarh refinery, Vedanta is far from securing supplies yet. It's importing bauxite from as far away as West Africa. Discussion to source the alumina intermediate from Nalco hasn't borne fruit despite years of negotiations while the Centre is still to begin the process of auctioning new bauxite reserves, despite repeated promises. "We have forgotten Niyamgiri. We move on. I must have lost a lot of money there but it was an era. It was an amazing era where we did not move a blade of grass and there have been allegations of illegal mining, moving people, removing people. This is the agenda whereby people don't want India to develop," says Agarwal.

The Cairn lease expires in 2020 and government has announced new lease terms, demanding an additional 10 per cent revenue share. Vedanta is baulking at it. "We are discussing with the government. It should be keen that people make money so they can re-invest. For an investor, many places are available to do business. But how can India be attractive? Governance is very important, so is transparency. But if people can make more money from India, it's better," says Agarwal.

Of the group's $1.25 billion group capex this year, which is double of last year, nearly 50 per cent is going into zinc; 30 per cent into oil; 10 per cent into copper and 10 per cent into aluminium.

SUNIL DUGGAL MD, Hindustan Zinc

The reason why zinc remains the mainstay is because of its potential. In 1990, the original resource in SK Mines was believed to be 18 million tonnes which would produce 0.3 mtpa of ore. In 2015/16, the estimates were revised to 109 million tonnes. Today, it's at 122 million tonnes (group reserves nearly 200 mt). Production is projected to ramp up to 6 mtpa, lasting 20 years. Between SK and adjoining Rajpura Dariba, the zinc ore potential could be as high as 400 million tonnes, says Sunil Duggal, Managing Director, Hindustan Zinc.

"Zinc has rallied in the short term. It will go for a short correction but the trend is on the higher side," says Prathamesh Mallya, Chief Analyst, Non-agri Commodities & Currencies, Angel Commodities Broking.

The group is in the process of further mechanisation to reduce production costs further. "Zinc is the bulk of their profits and valuation, especially because of uncertainty regarding sourcing of alumina/bauxite. HZL is looking good in how they are shaping up mine-metal production. About 20-30 per cent jump in production by FY2020 is clearly visible," says Ankur Kulshrestha, Research Analyst-materials, HDFC Securities.


While zinc could ring-fence the group from any adversities for a few years, Agarwal needs to sort out the bauxite sourcing puzzle after the Niyamgiri debacle. "In aluminium, since smelting in China is taking a hit and demand is stable, projection remains high," says Mallya. "All metals will be on the higher side in termsof pricing."

SAMIR CAIRAE CEO, Metals (India), Vedanta (Photo: Vivan Mehra)

Vedanta's bauxite business head Ajay Kumar Dixit explains the dilemma. The group intends to ramp up its aluminium production from 1.7 mtpa to 3 mtpa by 2020. Ramp-up has a significant effect on reducing cost of production. "We break even at slightly lower than $1400. As the plant ramps up, the distribution of asset costs over higher volumes happen and so our break evens would go lower," says Dixit. "In aluminium, 3 million tonnes of capacity in China will be closed by October/November. It can go up to $2300/2400 from $2050 today. Vedanta fortunes are good because of these two," says an analyst.

Vedanta would require 6 mtpa of the intermediate alumina and 18 mtpa of raw material bauxite. But its Chhattisgarh mines are producing barely 2-3 mtpa of bauxite. While that is being ramped up to 5 mtpa, Vedanta is still short of 13 mtpa. Even though India sits on the world's biggest bauxite reserves, Vedanta's bauxite is being imported from as far as West Africa.

And domestic sourcing is nowhere in sight right now. Niyamgiri bauxite ore may never get mined; years of discussion with government-owned Nalco for supply of alumina haven't reached any conclusion; and, Orissa and the Centre have yet to throw bauxite mines for auction. "Nalco depends on internal policy change. They are selling alumina internationally. We would be open to taking it. What we know is that they are doing some internal deliberations," explains Dixit. "Orissa has to give us bauxite. We would be open to take it from wherever they give. In any case, the government will also auction mines. We would prefer it from Orissa but we would take it also from Chhattisgarh."


If it's the government that's the bottleneck in bauxite, in oil it's for Vedanta to decide whether it wishes to ask for extension of lease for the Rajasthan block for another 10 years or not. The block that contributes nearly 90 per cent of Cairn's crude production is due for renewal in May 2020. Vedanta would have to put up its expression of interest by May 2018. The price it will have to pay, as per the new licensing policy Hydrocarbon Exploration Licensing Policy (HELP) is 10 per cent additional profit petroleum, something that Cairn firmly believes is usurious.

In March 2017, the government introduced HELP to double crude production from 80 million metric tons to 150-155 million metric tons by 2022. But existing lease owners will have to shell out more. Vedanta's Ravva lease extension is due in 2019 and Cambay in 2023.

"It seems that they have said that our Rajasthan Block is part of that policy. We have been under litigation much before this policy in the context that there is the bilateral contract with the government of India and that allows us an automatic extension at the same terms and conditions. The policy has been notified. On the face of it seems to be saying that you have an extension with clauses," says Sudhir Mathur, CEO, Oil & Gas Business of Vedanta Resources.

The peak tranche as per existing contract was 50 per cent profit petroleum which would now be at 60 per cent. "We feel that's a bit punitive," says Mathur.

The assumption being that all the investment that needed to be made has been made. Therefore, it is just an operating cost and so the government should collect more. But Mathur says technology is much more expensive: "On one hand if you use technology well of which there have been changes in fracking or 4D seismic, etc you tend to push up your recovery factors quite considerably with a high degree of surety as opposed to taking exploration risk. That high profit petroleum becomes punitive to attract investment which is something government needs to take into account."

Cairn reckons higher share of profit petroleum may force players to leave oil in the ground if it's not viable towards the end of the lease period. That's disastrous for a country that imports 80 per cent of its crude. However, both petroleum minister Dharmendra Pradhan and the regulator DGCA have indicated that tight and tougher reserves may be incentivised. "Then we won't need to worry about it," says Mathur.


"Nand Ghar" is a pre-fabricated house in some 100-odd villages, complete with solar power, hand pump and a TV. It provides nutritious meals to children in the village, health check-up and value-based education via TV. In the afternoon, women are trained in skills and in the evening farming-related information is provided to the villagers. Having tested the pilot in these villages, the Rs20-30 lakh house (excluding land which is the Panchayat's) is now being rolled out in 4,000 villages simultaneously. Agarwal, a Krishna devotee, couldn't make it to the birthplace during this visit but on his Mumbai stopover on the way to London a visit to the Siddhi Vinayak temple is a must. Meanwhile, he's doing the next best thing: setting up "Nand Ghar". Agarwal wants this expanded to 1 lakh villages.

SUDHIR MATHUR CEO, Oil & Gas, Vedanta (Photo: Vivan Mehra)

He has an indelible mark on India's commodities space. Now, the emphasis is on being a righteous businessman, a businessman with a heart. Agarwal says he's pledged 75 per cent of his personal earnings every year towards communities. Nand Ghar is one of the biggest initiatives to be funded by this. "My advice to the teams is to see that CSR goes beyond philanthropy and see it's matched with equal strength with community engagement so we don't create a dependency relationship between our CSR and those communities. We didn't see the strategic effects of that (in Niyamgiri)," says Albanese.

A sore point at Vedanta is the government's indecision on selling the remaining equity stake in Balco and Hindustan Zinc, something Agarwal has tried multiple times. Vedanta had acquired a 51 per cent stake in Balco in 2001 and 64.9 per cent of Hindustan Zinc in 2002-03 under the disinvestment proceedings under the Atal Bihari Vajpayee government.

"Disinvestment of the remaining government stake hasn't gone very far but it works for smaller investors because the government is also very keen on big dividends," says Kulshrestha of HDFC Securities. So Vedanta has issued a dividend guidance. "We have committed a minimum dividend of 30 per cent," says G. Arun Kumar, the group CFO.

That comes on the back of a healthier balance sheet.

G. ARUN KUMAR, Group CFO, Vedanta (Photo: Vivan Mehra)

Thanks to the gold rush, in the past two quarters Vedanta has shed Rs8,700 crore of debt, leaving it with a gross debt of Rs80,000 crore and a net debt of Rs 57,000 crore. "All our businesses are delivering IRRs over 20 per cent. Zinc is 40-50 per cent," says G. Arun Kumar. Between January and July, it has refinanced $3.8 billion in debt, raising the maturity profile from two years to 4.35 years and reducing consolidated cost of borrowings to under 8 per cent for the first time in its history. "I have a Net Debt/EBITDA of less than 1 in Vedanta Ltd. This is by far the best ratio if you look at other groups in India. The focus at Vedanta Ltd is to reduce the gross debt level. We have enough cash."

It's hard to believe that barely a couple of years ago the group was saddled with problems. It had $17 billion in debt with an interest outgo of nearly $1 billion per annum. Its $1 billion alumina production facility at Lanjigarh was closed temporarily in 2015 since bauxite could not be mined and, commodity prices barring oil were nose-diving.

With strengthening financials from zinc, aluminium and copper, in particular, no challenge seems insurmoutable for Vedanta.

If this lasts 5-7 years as Agarwal is predicting, expect Vedanta to make more bold bets. That could include an acquisition in steel, with several NCLT-stricken steel assets coming up forbids soon. Expect Agarwal to strike when the iron is hot.