Is Vedanta a Good Long-Term Investment for the Next 15-20 Years?
The question of whether Vedanta is a good long-term investment has been the subject of much debate, particularly given the current stock price and the adoption of dividend distribution policies. In this article, we will explore the reasons why investing in Vedanta stock may not be the best choice for a long-term horizon of around 15-20 years.
Risks and Implications of Current Dividend Policy
One of the primary concerns with investing in Vedanta is the dividend policy adopted by the company. It is widely believed that there are not many reasons to buy Vedanta stock. The current trend of high dividend payouts, which have reached nearly 10–12%, is unsustainable. This policy will eventually lead to negative returns in the investor's portfolio once the dividend trend comes to an end.
Why High Dividend Payout is Not Feasible for Long-Term Investors
In 2020, Vedanta announced plans to delist the company, citing a stock price below 100 and a valuation of just 20,000-25,000 crore. Initially, the company aimed to delist at a lower price and withdraw all dividends. However, their plan failed, and they are now required to distribute dividends to all investors.
A significant factor contributing to high dividend payouts is Vedanta Resources, which is listed on the London Stock Exchange. This company has taken a substantial loan to expand its operations, amounting to around 8 billion dollars. When this loan needs to be repaid, Vedanta may be forced to sell its stake or distribute dividends to its shareholders, further exacerbating the dividend payout issue.
Current Financial Stability and Debt Levels
Let's explore the current financial state of Vedanta, including its earnings per share (EPS), debt levels, and industry comparisons.
Over the past three years, the EPS of Vedanta has averaged around 30 rupees per share, but the company has been distributing 45 to 65 rupees in dividends. This raises significant questions about the company's financial health and sustainability.
The graph clearly indicated that the company's debts are rapidly increasing, with the cash balance on the balance sheet declining from 70 billion to an alarming 52 billion crores. This financial instability is a critical factor to consider before investing in Vedanta for the long term.
Vedanta operates in the metals and mining industry, where capital-intensive projects require significant funds. For example, setting up a copper plant can cost 6-8 thousand crores. Given the current financing methods where most payments are made through loans rather than through cash flows, these debt levels pose a significant risk for future operations.
The Future of the Stock and Valuation
The current stock price of Vedanta is around Rs 513, with a market capitalization of around 2 lakh crore. The company's profit last year was just 7500 crore, yet we are paying it a market cap of 2 lakh crore. The price-to-earnings (PE) ratio is around 31, which is significantly higher than the industry average. To put this in perspective, compare this with Coal India, a similar company in the industry, which has a PE ratio of only 7-8.
Some analysts claim that Vedanta will repeat similar profits in the next financial year. However, it is important to note that the increase in profits is primarily due to changes in commodity prices post-COVID. The margins from 2017 to 2019 were around 25-30%, and last year's margins are similar. On average, the margins are approximately 27%.
According to projections, even if Vedanta achieves an expected revenue growth of 5-6% per year over the next few years, the maximum net profit for March 2025 is estimated to be around 17,000 crore. Assuming a PE ratio of 12, the stock's valuation would be around 100,000 crore, significantly lower than the current valuation.
Falling Metal Prices and Commodity Cycles
Commodity prices, such as metals, are cyclical. Even though prices increased significantly after the COVID-19 pandemic, this trend is unlikely to continue. The increased prices in one cycle will be followed by a decline in the next cycle. Therefore, metals and mining companies like Vedanta are typically valued at a PE ratio around 8-10. Valuing Vedanta at a PE ratio of 12, as we see now, is irrational.
Future Perspective and Alternative Investments
For long-term investors, it is crucial to consider the risks associated with high debt levels and foreseeing commodity cycles. Given these factors, it is advisable to avoid Vedanta and consider investing in other sectors. For instance, companies in the paints and precision engineering sectors, such as 3M India, offer better long-term prospects.
There has been news about a potential demerger of Vedanta, which could present a strategic investment opportunity. However, the demerger process is lengthy and involves obtaining shareholder and regulatory approvals, making it risky for investors. It is best to stay away from Vedanta until the demerger is final.
Conclusion
This analysis provides a comprehensive view of why investing in Vedanta for the next 15-20 years may not be the best choice. While taking dividends may seem attractive, the underlying financial health and long-term sustainability of the company are questionable. Ensure to conduct thorough research and make informed decisions based on your investment goals and risk tolerance.
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