Vedanta’s tangled debt, dividends, demerger: Where do shareholders stand?

If you’d bought one share of Vedanta for ₹142 in November 2019, you’d have received ₹191 in dividends, and that share is now trading above ₹430. Some analysts have a ₹600 target price.

And yet, the one thorn in its side that’s keeping investors cautious – despite the company’s promises and management's multiple restructuring efforts – is Vedanta’s accumulating debt.

Last year, Vedanta was in a do-or-die situation as it had upcoming debt repayments. This year it has settled its FY25 debt repayments, but the firefighting could resume next year. If the company is struggling to pay its debt, why is it pampering shareholders with rich dividends?

The answer lies in its complex corporate structure and the huge debt it has accumulated in the past few years by acquiring sick assets.

Vedanta’s never-ending firefighting

The parent company Vedanta Resources Limited (VRL) is based in the UK and chaired by Anil Agarwal. It is a holding company that has a more than 50% stake in the operating company Vedanta Limited (VDL). VRL’s major source of income is dividends and brand fees from VDL.

The irony is that VDL has a huge cash reserve locked in its equity. The holding company, VRL, made several attempts to restructure its business to use VDL’s cash reserves to reduce its debt. In 2018, VRL delisted itself from the London Stock Exchange. In 2020, VDL tried to delist from NSE but failed as it could not secure the required 90% acceptance level.

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Had VDL's delisting been successful, VRL could have accessed the ₹54,000-crore reserve locked in VDL’s equity capital in FY20. As that didn’t happen, the group was left with just one option – liquidating those reserves in the form of dividends. From there began the saga of incredible dividends.

Of the ₹41,149 crore and ₹20,500 crore of dividends paid in FY23 and FY24, more than 56% went to VRL, which it used to reduce its debt from $9.1 billion in FY22 to $6 billion in FY24. All these dividend payouts reduced the equity capital reserves VDL had built from accumulating years of profits.

VRL started FY25 with debt of $6 billion, of which $4.1 billion was maturing in FY25. However, it managed to restructure its outstanding bonds worth $3.2 billion, extending their maturity up to FY29. It now has to pay a total of $918 million in FY25, and $1.8 billion in the next two fiscal years. This bond restructuring has bought VRL some time to repay its debt, which means VDL’s heavy dividend payouts could ease.

Apart from bond restructuring, the holding company also reduced its debt to $4.8 billion in Q2 of this year, and aims to reduce it further in the next two years.

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So behind VDL’s rich dividends were the payments to creditors of the holding company. And, as you know, creditor payments take priority over shareholder returns. However, VDL’s strategy to access the reserve money through dividends created an opportunity for retail shareholders to make hay while the sun shines, and get a share from the reserve money.

In this whole episode, traders who bought VDL stock only to earn the dividend and then sell it made no money. If you look at the chart below, the stock fell in eight of the past 15 dividend announcements. After all, the money was leaving VDL and the debt kept piling up. However, shareholders who adopted a buy-and-hold strategy throughout the deleveraging through dividends earned triple-digit returns in the past five years, with a cumulative dividend per share of ₹191.

Next challenge: debt

The parent company VRL has been pulling cash out of the operating company VDL to repay its debt. While VRL reduced its debt, VDL kept adding more. VDL’s gross debt increased from ₹53,583 crore in FY22 to ₹87,706 crore in FY24. In May 2024, VDL used its subsidiary Vedanta Semiconductors to raise ₹1,804 crore in secured debt from private creditors by pledging Hindustan Zinc shares. Like this, 100% of promoter shareholding has been pledged against several loans. In short, the group has been busy digging more debt holes to fill previous ones.

The promoters are locked in as they cannot sell their pledged shares to raise more capital to repay debt and fund capital expenditure. And unsecured private debt is expensive. In the second quarter, VDL got some room to raise ₹11,633 crore through qualified institutional placement and the sale of a 2.6% stake in HZL. It used this money to reduce gross debt to ₹78,65 crore. All these efforts to reduce debt got VDL a ratings upgrade from AA- to AA from ICRA.

The key challenge for VDL is to meet its next three years of debt repayments.

The company is trying to juggle three things:

• VDL’s humongous ₹78,650-crore gross debt, of which ₹48,100 crore is due in the next three years.
• VRL’s $4.8 billion ( ₹40,500 crore) debt.
• Capital expenditure of $6 billion ( ₹50,600 crore) over the next three years

It needs ₹88.trillion crore over the next three years to meet these obligations. It has ₹21,720 crore in cash and another ₹30,000 in accumulated reserves, which it has been using to pay large dividends. The company relies heavily on its operating profit to meet these obligations.

Hence, investors should keep a close eye on VDL’s operating profit. Any sharp dip in that could pose a risk for the company and pull the stock price down.

Debt expectations don’t add up

It is not strange for a mining or oil company to have huge debt. Mining companies around the world have leveraged balance sheets and Vedanta is no exception. However, the others have longer debt repayments. Vedanta’s challenge is its short repayment schedules, with an average term debt maturity of around three years.

These debt repayments become a challenge during a cyclical downturn, when commodity prices fall and eat up profits. The FY15 and FY16 downcycles pushed Vedanta into losses. It reported a net loss of ₹11,369 crore in FY15 due to falling oil prices and ₹17,862 crore in FY16 as expenses exceeded revenue. The fact that Vedanta never missed a debt payment even in such downturns is commendable.

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However, in April 2023 Anil Agarwal said he would make Vedanta Group net-zero debt in three years. This seemed too aggressive and slightly detached from reality. It’s been a year and a half since he made that statement, and VRL’s falling debt levels have been partly funded by VDL’s rising debt levels. To ease the pressure of VDL’s upcoming debt repayments, Agarwal has yet again proposed a new business structure that is the exact opposite of delisting.

Demerger of the mining conglomerate

If Vedanta cannot delist from the share market, why not monetise its presence and attract equity capital? A conglomerate structure that has diverse businesses usually suffers a big discount in valuation as high-value businesses bear the burden of low-value businesses.

VDL has proposed to demerge its businesses into six separate entities and decentralise management. All six companies will be listed on the stock exchange and have independent capital structures and the freedom to attract investors. Existing shareholders will get one share of each of the six entities for every share of VDL.

Pros: A demerger could be a quick fix to Vedanta’s ticking debt. When the company demerges, management divides the assets and the debt. A Forbes India article citing company sources stated that VDL will divide the debt in the ratio of assets allocated to them. So far, the company has secured approval from 75% of its secured creditors and has filed an application with the National Company Law Tribunal (NCLT). If everything goes as planned, Vedanta expects to complete the process by March 2025.

While a demerger may not affect the company’s debt repayment capability, it will divide this responsibility among six entities. Here, the failure of one may not affect others. Moreover, it will allow the new entities to raise new equity capital while VDL’s stake in these entities from the pledged shares remains intact.

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Cons: The demerger could unlock shareholder value, but could also increase volatility for the demerged entities, exposing them to their pure-play metal prices.

While the demerger is in the works, uncertainty exists. The company has to get all the necessary approvals and implement the demerger in the manner it has proposed without material alterations. Given that many of Vedanta’s past restructuring attempts didn’t materialise, it would be better to wait and watch how the demerger unfolds. If it falls apart like its 2020 delisting plan, the stock could see a pullback.

In conclusion

To sum up the investing case, there could always be a slip between the cup and the lip, such as a failure of bond restructuring or accumulating more debt. While this could pull the stock down in the short term, the company could recover from it.

Vedanta Limited has strong revenue and profits thanks to cost advantages and a near monopoly in India. Yet, it is better to tread with caution as the stock could fall anytime depending on the global commodity market.

For a cyclical and highly leveraged stock like Vedanta, the price-to-equity (PE) ratio may not be the right metric. Investors should look for healthy operating profit and debt-to-operating margin. For now, it’s best to wait and watch how the company conducts the demerger and unlocks value for shareholders.

For more such analysis, read Profit Pulse.

Note: We have relied on data from Screener.in throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.

The purpose of this article is only to share interesting charts, data points, and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only.

Puja Tayal is a seasoned financial writer with more than 17 years of experience in fundamental research. She brings a good blend of comprehensive, well-researched insights into a company’s work in her articles.

Disclosure: The writer and his dependents do hold the stocks/commodities/cryptos/any other asset discussed in this article.