Billionaire Agarwal Faces Higher Costs on Oil Drop: India Credit

By Abhishek Shanker and Anoop Agrawal

Photographer: Scott Eells/Bloomberg

Anil Agarwal, chairman of Vedanta Resources Plc.

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• Vedanta and Oil

A drop in oil that spurred the best Indian sovereign debt rally in six years wasn’t such good news for resource bonds.
Dollar notes of Vedanta Resources Plc (VED), controlled by Indian billionaire Anil Agarwal, are the worst performing this month in a Bank of America Merrill Lynch index of Indian high-yield securities and Standard & Poor’s put the nation’s biggest onshore oil producer on negative credit watch on Jan. 6. Debt due in 2019 of JSW Steel Ltd., owned by the Jindal family, are at 92.4 cents on the dollar from par when they were sold in November. Perpetual dollar bonds of Mukesh Ambani’s Reliance Industries Ltd. lost 1.4 percent last month.
Vedanta’s potential downgrade and a spike in its default risk to an 18-month high could make it harder for the company to raise funds and it may have to curb expenditure, S&P said. With Societe Generale SA and Bank of America Corp. saying oil could reach $40-a-barrel and
below, fund managers including Aquila & Co. say it isn’t yet time to buy Indian resource bonds.
These companies “have to face the reality of getting less money for what they’re doing and paying a higher price for capital,” said Michael Ganske, the London-based head of emerging markets at Rogge Global Partners Plc, which manages about $55 billion of notes. “That’s a normal cyclical pattern, it just came very quick and sharp this time, and investors have no clue where oil is going in the coming months.”

Oil Losses

Oil slumped 46 percent last year, the most since 2008, as the Organization of Petroleum Exporting Countries resisted cutting output amid a U.S. shale boom. West Texas Intermediate may fall to $40 a barrel this quarter, Australia & New Zealand Banking Group Ltd. said in a Jan. 15 note.
Crude’s fall is a boon for India, which satisfies 80 percent of its demand overseas. The slide will cut the annual oil import bill by about $50 billion, Press Trust of India reported on Jan. 13, citing the Reserve Bank of India.
Earnings as a percentage of sales Vedanta makes from oil and gas before interest, depreciation, taxes and amortization may tumble to about 40 percent in the 12 months to March 2015, from about 52 percent, and any recovery in the company’s weak financial ratios will be “materially delayed,” S&P said on Jan. 6.
Credit-default swaps on Vedanta surged to 619 basis points on Jan. 15, the most since November 2012, according to data provider CMA. Swaps on Reliance Industries touched 215.8 basis points on Dec. 16, the highest since February last year.

Refinancing Risk

“This has heightened the refinancing risk for Vedanta,” Nomura Holdings Inc. Hong Kong-based credit analyst Abhimanyu Talwar said in a Jan. 7 note. “We reiterate our underweight call given the sharper-than-expected decline in oil prices.”
Nomura said Vedanta’s dollar bonds are structurally subordinate to the about $9 billion of debt at its unit Sesa Sterlite Ltd., which has high funding needs and weak cash flow.
“Vedanta’s financial ratios will weaken because of the fall in crude oil prices,” Mehul Sukkawala, a Singapore-based analyst at S&P, said on Jan. 6. “It’s more about the cash flows that are affected as a result of the drop.”
The extra yield over government debt on Vedanta’s 7.125 percent 2023 dollar notes jumped 376 basis points over the past month to 1091 basis points. The premium on Oil India Ltd.’s 5.375 percent notes due 2024 rose 23 to 249.6.
“In the worst case, Vedanta’s earnings losses from its oil businesses could widen to $1 billion in the year starting April 1,” Alan Greene, a Singapore-based analyst at Moody’s Investors Service, said by phone on Jan. 13. “With lower earnings, leverage will go up.”

Good and Bad

Earnings from regular operations of state-owned producers such as Oil & Natural Gas Corp. and Oil India could be about 15 percent lower this financial year, according ICRA Ltd., the Indian arm of Moody’s. Refiners including Reliance will face higher losses on the value of inventories, leading to negative or very low gross refining margins in the quarter ended Dec. 31, ICRA said.
“I certainly wouldn’t go for the ones with issues in this environment,” said Patrik Kauffmann, a money manager in Zurich at Aquila & Co., which manages some $10.7 billion. “The market isn’t differentiating between good and bad companies. I’d wait until we see a bottoming out of commodity prices.”
Oil’s slump has turned investors’ attention toward Vedanta’s zinc business, India’s largest, Goutam Chakraborty, an analyst at brokerage Emkay Global Financial Services Ltd. said by phone from Mumbai on Jan. 13.
Zinc could “throw up a few surprises in terms of higher volumes and better price realization,” said Chakraborty. Vedanta may buy the government’s stake in unit Hindustan Zinc Ltd., giving it access to $4 billion in cash, he said.
Rogge’s Ganske, who holds Vedanta notes, said he would consider buying resource company bonds at the right price.
“When and if there’s a turnaround, these bonds will be outperformers,” he said. “We’re experiencing the last leg of the oil price correction.”