Credit Opinion: Vedanta Resources Plc Global Credit Research - 29 Jul 2010

London, United Kingdom

Ratings Category
Outlook Corporate Family Rating Senior Unsecured

Moody's Rating
Stable Ba1 Ba2

Contacts Analyst
Alan Greene/Singapore Philipp L. Lotter/Singapore Gary Lau/Hong Kong

Phone
65.6398.8318 65.6398.8335 852.3758.1377

Key Indicators
[1]Vedanta Resources Plc

Fiscal Year Ending March 31

EBIT Margin % Return on Average Tangible Assets (%) Adj. Debt / Adj. Capital (%) Adj. Debt / EBITDA (x) EBIT / Interest (x) Operating Cash Flow - Dividends / Adj. Gross Debt (%) Free Cash Flow / Adj. Debt (%)

2007 40.3% 37.0% 32.6% 0.7 13.6 70.4% 17.8%

2008 35.3% 24.2% 24.1% 1.0 9.3 63.6% 14.9%

2009 24.1% 9.9% 40.3% 2.7 4.0 31.3% -17.5%

2010 25.4% 10.1% 42.0% 3.4 3.7 14.8% -9.0%

[1] Ratios for all periods reflect Moody's standard adjustments (see "Moody's Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Companies - Part 1 & 2", February 2006).

Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide.

Opinion Rating Drivers

- Size, diversification across base metals and solid reserve life translate into strong business risk profile - Aggressive expansion plan provides growth potential -- if successfully executed -- but it also increases leverage - Solid liquidity profile - Among lowest cost producers but profitability remains closely tied to metal prices - Complex corporate structure due to lack of full ownership of key subsidiaries

Corporate Profile
Headquartered in London, UK, Vedanta Resources plc ("Vedanta") is a diversified metals and mining company with interests in India, Australia and Zambia. Its main operations are held by Sterlite Industries (India) Ltd ("Sterlite"), a 57.7%-owned subsidiary which produces zinc, aluminum, copper and lead. Vedanta also owns a 55.7% equity stake in Sesa Goa, India's largest exporter of iron ore in the private sector. Listed on the London Stock Exchange, Vedanta is 61.2% owned by Volcan Investments Ltd. For the year ended March 2010, Vedanta generated revenues of US$7.9 billion and EBITDA of US$2.6 billion.

SUMMARY RATING RATIONALE

The Ba1 corporate family rating reflects Vedanta's: 1) low-cost position; 2) business diversity, as reflected by its presence in the copper, zinc, aluminum, iron ore and power businesses; 3) track record in implementing capacity expansions; and 4) solid liquidity profile.

At the same time, the corporate family rating reflects the: 1) volatility of base metal prices; 2) execution risk associated with the substantial growth projects underway; 3) expected increase in leverage (on an adjusted gross debt to EBITDA basis) as a result of substantial organic and inorganic expansion plans; and 4) complex corporate structure and modest financial profile of the standalone holding company (Parent company).

DETAILED RATING CONSIDERATIONS

BUSINESS RISK PROFILE SUPPORTED BY BASE METALS DIVERSIFICATION Vedanta enjoys a reasonable degree of diversification in terms of its base metals exposures. And with the different expansion plans that it is implementing across its base metals portfolio, it aims to become one of the top 5 base metals companies over the medium term. Acquisitions are integral to the strategy. In May 2008, Vedanta made a $2.6 billion bid to buy Asarco, the US-based copper mining and refining business, out of Chapter 11. This was subsequently revised down to US$1.7 billion to reflect market turbulence, then back up to US$ 2.6 billion but ultimately the former owners of Asarco repurchased the Asarco business in November 2009. In June 2009, Vedanta through its subsidiary Sesa Goa, acquired Dempo Group's iron ore assets for US$368 million. Further, in May 2010, Vedanta announced the acquisition of the zinc assets of Anglo American plc for US$1.4 billion through its subsidiary Hindustan Zinc Ltd ("HZL"). Pending final clearances, the transaction should be completed in Q3 FY2010, although profit accrues to Vedanta from January 2010. In 2009, Anglo recorded revenues of US$717million and EBITDA of US$227million from these assets. The main use for zinc is in the corrosion protection of steel through plating or galvanising. The demand is thus ultimately related to construction and Vedanta expects strong growth from this sector. In other applications substitute materials have taken over. Therefore, while Anglo regarded its zinc assets to be non-core, for Vedanta the business is an opportunity to consolidate its position in zinc, where the company believes it can achieve cost leadership supported by solid reserves. For FY2010, the copper and zinc businesses remained the main contributors to Vedanta's consolidated revenue, accounting for approximately 48% and 21% respectively of its consolidated revenue. However, in terms of EBITDA and overall cash generating ability, it is the added value from the mining of the ore rather than refining and marketing activities that currently dominates the outturn. In FY2010, the EBITDA contributions by the main business areas were thus: zinc 43%, iron ore 29%, copper 14% and aluminum 7%. The rapidly growing commercial energy business contributed the remaining 7% of Vedanta's consolidated EBITDA. Progressive commissioning of its commercial power plants will add a further and potentially less volatile business to its portfolio. So far, Vedanta has been selling surplus power from captive power generators at its now closed aluminium works at BALCO and MALCO. Moreover, in FY2010, Vedanta sold surplus power from its newly commissioned 1215 MW captive power plant at Jharsuguda, which is tied to the 500 ktpa aluminium smelter. Vedanta has also restarted its 1980 MW Talwandi Sabo IPP, which was earlier deferred in light of the weak operating environment. This project, together with the 2400 MW IPP at Jharsuguda is expected to substantially increase Vedanta's commercial power availability, in addition to the company's plans to conitinue selling surpluses from its captive power plants. Geographically, the company remains heavily focused on India, where most of its operations and assets are located. It is management's expectation that at least 75% of the business will always be in India. The purchase of Anglo's zinc business provides modest enhancement to the geographic spread although the business will operate as a subsidiary of HZL. Anglo's operations are in Ireland, Namibia and South Africa. Vedanta's ex-India activities are the copper mine-based operations in Tasmania and Zambia. IMPROVING RESERVE LIFE In terms of reserves, Vedanta has a solid reserve life for its rating category. Overall, the reserve life of Vedanta's mineral bodies is around 20 years, with a solid reserve base in zinc, iron ore and copper, but has a shorter reserve life in bauxite. However, the company has a strong track record of successful mine additions and exploration and continues to add new resources in excess of annual output. The Anglo assets operations in Ireland and Namibia have about 6 years mine life at current production rates, but the Gamsberg deposit in South Africa is believed to be one of the largest undeveloped deposits in the world potentially yielding 400ktpa of zinc over a 20 year mine life. Vedanta's current bauxite reserves are low, considering the alumina requirement and the relatively high bauxite-alumina ratio. Typically, producers require around 6 tonnes of bauxite to produce 1 tonne of aluminum. The company has obtained approval from the Indian Supreme Court to start operations at the Niyamgiri mine, which has a bauxite reserve of 78 million tonnes. Mining has yet to start, and so the new alumina operation at Lanjigargh, currently running at a production rate of 1.4mtpa, is being supplied from mines owned by BALCO and third parties located some distance away. Although the Niyamgiri Hills mine has enhanced the company's bauxite reserves, Moody's notes that the bauxite requirements for the announced aluminum smelting expansion plan of 1.25mtpa at Jharsuguda and 325ktpa at BALCO, on top of the existing 750ktpa capacity, will rapidly exhaust the reserves at Niyamgiri. Nevertheless, Vedanta is confident of obtaining additional bauxite mining rights from the government, as bauxite is abundant in the state of Orissa. SHARP REVERSAL IN INDUSTRY DYNAMICS PROMPTS GREAT UNCERTAINTY The financial crisis of Q3 2008 provided a shock to the global demand for base metals, which led to the prices of all metals dropping by 50% or more from their 2008 peaks. The declines were particularly sharp in the last two months of the year and softness continued in the first few months of 2009. Subsequently prices have exhibited a fair amount of volatility, reflecting global easing of monetary conditions and the impact of various governmental supply-side stimuli, of which China's infrastructure package was among the first and largest. In response to the collapse in demand, many metals and mining companies reduced production. Due to the high start-up costs, producers are particularly reluctant to switch off aluminium smelters, but across all metals, inventories initially rose as production rates continued to exceed the loss of demand. The base metals business remains heavily dependent on China both in terms of its domestic infrastructure requirements and the state of its exporting industries. The rebound in the Asian economies, led by China, has subsequently helped to drive base metal prices in Q1 2010 to levels approximately twice those seen in Q1 2009. However, aluminium and, to a greater extent, steel, have lagged the price recovery trend.

In recent months the iron ore trade has been in focus. The three largest international ore suppliers - BHP Biliton, Rio Tinto and Vale - who produced a combined 582 million tonne of iron ore in 2009, have moved from annual contract reviews with their key customers to quarterly, index-linked pricing. Buyers of ore, chiefly the chinese steelmills, are hoping to achieve lower prices, closer to spot levels with this mechanism. The spot market for iron ore is relatively undeveloped but could capture a greater share of global iron ore trading in the new pricing environment. In order to mitigate more volatile input prices and protect margins, steel companies will probably hedge their iron ore costs or seek to introduce some indexed, cost pass-through on their products. While Sesa Goa's product attracts lower prices than the mainstream, traded iron ore, Moody's will watch market developments closely in the coming months. Sesa Goa produced 21.4 million tonnes of iron ore in FY2010 the majority of which is sold on the spot market. 82% is in the form of fines which Indian steel mills are not well-equipped to handle. Some 94% of output in FY2010 was exported, of which 84% was sold to China. Sesa Goa has plans to expand to an output rate of 50mtpa. As India's steel industry grows, it is possible that the government might seek to restrict iron ore exports. To date, government measures in 2010 have been confined to raising export duties back to the levels seen in 2008, with a 5% tax on fines and a 15% tax on iron ore lumps. AMONG LOWEST COST PRODUCERS BUT PROFITABILITY REMAINS CLOSELY TIED TO METAL PRICES Vedanta benefits from a competitive cost position, reflecting the (a) integrated nature of its operations; (b) low-cost reserves, mainly in zinc; and (c) productivity enhancements implemented in recent years. The company was in the lowest cost quartile for its zinc mining operations in 2008. Despite its lower than average production costs, its top line performance and profitability were materially impacted by the collapse in metals prices since September 2008. Vedanta's revenues declined by 20% in FY2009, while EBITDA almost halved due to the sharp decline in prices in the second half of the year. However, volatility has benefited the company on the upside with EBITDA and credit metrics improved sharply in FY2010. The cost structure of the aluminium businesses has been relatively weak compared with the zinc, copper and iron ore activities. The market slump in 2H FY009, gave Vedanta the opportunity to shut down production at its higher cost aluminium smelters - namely MALCO and BALCO Plant I. The captive power plants at these operations continued generating, with the energy sold to third parties. The old smelters are unlikely to be restarted; Moody's notes that the smelting cost of the new BALCO Plant II smelter is in the second lowest cost quartile for production. The overall cost structure of the aluminum business should improve further once it starts feeding its alumina refineries with bauxite from the Niyamgiri mines. Action has also been taken on its Zambian copper operations. After recording negative EBITDA of $71 million in FY2009, a vigorous cost reduction programme, centred around the closure of an old smelter and the commissioning of the more efficient Nchanga smelter, in conjunction with better mining performance, led to the achievement of positive EBITDA of $152 million in FY2010. As Vedanta's product selling prices vary, so also do its input costs, the largest of which are also commodity-related such as fuel, power and chemicals. If commodity prices move broadly in tandem, then the degree of margin compression from falling metal prices is offset by lower costs albeit with some timing and inventory lag factors. BASE METAL PRICING RECOVERY IN FY2010 BUOYED CREDIT METRICS After testing Moody's tolerance levels for the rating in late FY2009, Vedanta's key financial metrics have recovered, as expected, in the more positive pricing environment for base metals and are better able to accommodate the aggressive expansion strategy and the incremental debt funding. Vedanta has continued to issue debt. Two convertible bonds were issued in FY2010, US$1.25 billion in July 2009 and US$883 million just prior to the year end in March. In total the Group paid back some US$1.2 billion of debt and raised US$4.2 billion of new funds in FY2010, including US$1.1 billion of new equity raised by Sterlite Industries. Debt levels are expected to peak in FY2012, in tandem with the peak in its capital expenditure over the next two years. Moody's notes that Vedanta's gross debt could remain in the range of US$10-12 billion over the next 2-3 years, which may pressurize the company's financial metrics should there be any further weakening in the operating environment for base metals. However, Vedanta's stable outlook is supported by the expectation that its financial profile will strengthen again beyond FY2010, once the new projects gradually come on-stream and start generating the expected returns. Furthermore, Vedanta's strong liquidity, with cash and cash equivalents of about US$7.2 billion (as of March 2010) provides comfort on the company's capacity to withstand any contingencies or weakening in metal prices. Nevertheless, we note that the aluminum expansion projects will not start to generate significant cash flows until they begin progressive commissioning from FY2011 and are fully commissioned by FY2012, and this will expose Vedanta to execution risk relative to its ability to bring them on-stream on schedule and within budget. Moody's also notes that Vedanta remains committed to a conservative financial policy as reflected by a maximum Net debt/EBITDA<2.5x and maximum gearing<40%. COMPLEX CORPORATE STRUCTURE Despite Vedanta's strategy of consolidating minority stakes in its subsidiaries in order to streamline the group structure, Moody's also takes into consideration the fact that it does not wholly own all of its operating subsidiaries, with regard to its respective 57.7% and 55.7% shareholdings in Sterlite and Sesa Goa, as well Sterlite's 64.9% and 51% shareholdings in HZL and BALCO. Moody's notes that while Vedanta does seek to increase its holdings in the listed subsidiaries, purchases may likely occur only after their stake has already been diluted by an equity raising by the subsdiary. Vedanta is still waiting for the chance to increase its interests (held by Sterlite) in HZL and BALCO through the exercise of call options pursuant to agreement with the Government of India. The option to buy the government's 29% stake in HZL has been exercisable since April 2007, but discussions with respect to previous stake transactions continue to hinder progress. The option in respect of BALCO has been exercised, but is pending arbitration. Should both these buy-outs occur, Moody's estimates that around US$2.4 billion would be required in consideration.

Moody's view is that the group structure remains very complex. Therefore, in addition to analyzing the consolidated profile of Vedanta, Moody's also monitors the company's operating performance by adjusting its credit metrics to reflect the pro-rata consolidation of the operating subsidiaries that Vedanta does not fully own. On a proportionate consolidated basis, Debt/ EBITDA increased from 3.4x to 5.9x as of March 2010 because of the increasing proportion of EBITDA generated by subsidiaries that Vedanta does not fully own. Since its IPO in December 2003, the UK parent company has paid dividends, in effect, from paid-in share capital. Aggregate losses earned in the Parent company, for FY2004 to FY2009 inclusive, totaled US$68 million, while dividends paid in this period amounted to US$421 million. In FY2010, Vedanta Resources Holdings Ltd., the immediate holding company subsidiary received a dividend of US$500 million from its subsidiaries and was thus able to pay a dividend to the Parent plc of US$437 million, which in turn paid US$118 million to the plc shareholders. In addition to the dividend payments, distributable reserves have been further eroded by the Company's purchase of its own shares. In order to rebuild the distributable reserves, Vedanta is once again seeking Court approval to reduce the share premium account and to credit the amount of US$190 million to the Profit & Loss reserve after the AGM to be held in July 2010. In April 2010, Vedanta established a Jersey-based connected vehicle to undertake its Treasury share purchases in order to shield the Parent distributable reserves from further erosion.

Liquidity Profile
Vedanta's strong liquidity profile is supported by its high levels of cash and liquid assets. As at 31 March 2010, the company had consolidated cash-on-hand and short-term investment balance of US$7.24 billion, with reported debt of US$8.17 billion. In addition, it had availability -- under unutilized fund-based credit lines -- of around US$2.0 billion as of June 2010. Liquid investments are in the form of highly-rated mutual funds, which are mostly denominated in Indian rupees. The overall debt maturity profile is well spread. The next large debt maturity is in FY2013 when the US$1.0 billion syndicated loan matures and US$654 million falls due at Vedanta Aluminium. As at March 2010, borrowings at the Parent company comprise US$1,535 million of bank loans and $1,250 of bonds. It guarantees a further US$2.13 billion of convertible bonds and US$1.06 billion of liabilities related to operating companies. In addition, Vedanta held some US$320 million of cash and bank deposits at the Parentmcompany level and US$200 million of available bank lines as of June 2010. In December 2008, Vedanta first announced an up to US$250 million share buy-back programme. By FY2010, the amount of Treasury stock acquired totalled US$429 million and the programme target has been further increased to US$825 million. Although the free float is only 38.5% of the issued equity, as a FTSE 100 company, Vedanta's shares are relatively liquid. The Treasury stock can be used to make modest share based payments or potentially be regarded as an alternative source of cash given that remittances from India can incur delays due to the approvals' process. Further equity based fund raising is anticipated in the current year; Sterlite Energy lodged a draft prospectus for its IPO in October 2009 and this could inject up to US$ 1.1 billion of equity into the Group. The combination of operating cash flow, cash-on-hand, short-term investments and Treasury stock, together with availability under unutilized fund-based credit lines, will be sufficient to meet cash calls over the next 12 months, including capex, debt maturities and dividend payments. The rating also assumes continued covenant compliance management by Vedanta. In this context, negative rating pressure could develop in the event that weaker-than-expected profitability reduces significantly the headroom under the company's financial covenants.

Structural Considerations
The Ba2 long-term debt rating reflects the complex nature of Vedanta's group structure and the likelihood that future debt raised at its operating subsidiaries -- in particular, the project finance debt related to the different power projects -- will subordinate holding company debt. Vedanta itself has no tangible operating assets and all the UK holdco and finco issues are unsecured. In addition, Vedanta's ability to call freely on liquidity from its Indian subsidiaries, in particular the listed subsidiaries, is uncertain and remains to be tested. The Parent company is pivotal in raising funds for the Group at the lowest possible post-tax cost. Vedanta achieves this although in Moody's view, the Parent operates on a fine balance of net interest receipts, management fees and net dividend payments. The complexity is unlikely to be resolved before the tiers in the structure are removed, giving Vedanta a clearer line of sight to its operating entities. At the Parent level, the debt:equity ratio was 7.0x at FYE March 2010 having declined from 10.7x a year earlier. As of March 2010, subsidiary debt as a percentage of total consolidated debt is significant at 44%, and the ratio of subsidiary debt to total group assets is also high at 15%. In Moody's view, attaining a consistent subsidiary and secured debt of below 15%-20% of consolidated debt, and total group subsidiary debt to total group assets of less than 10%-15%, would be required to equalize the ratings.

Other Considerations
GRID-IMPLIED RATING In accordance with Moody's global rating methodology for mining companies (Refer to Rating Methodology: Global Mining Industry, May 2009), Vedanta's overall performance measurements relative to the rating methodology indicate a Baa rating category when using average financials for FY2010A to FY2012E. The rating assigned differs from the outcome of the methodology model to reflect the: 1) company's complex group structure, as Vedanta does not wholly own its major operating entities, including its respective 57.7% and 55.7% shareholdings in Sterlite and Sesa Goa (as well as Sterlite's 64.9% and 51% shareholdings in HZL and BALCO), but fully consolidates these subsidiaries for accounting purposes; and 2) execution risk with respect to Vedanta's substantial expansion plan.

Rating Outlook
Vedanta's stable outlook is underpinned by its strong liquidity profile, and Moody's expectation of a progressive improvement in the company's financial profile beyond FY2010. This is balanced against a challenging operating environment, as well as the risk of further investments beyond

the large amount already committed. Moody's notes, however, that there is a degree of tolerance in the rating for further debt-financed expansion plans or for modest deterioration within the operating environment for base metals.

What Could Change the Rating - Up

Positive pressure on the rating could emerge if 1) Vedanta develops a stronger capacity to absorb commodity price volatility, derived from an enhanced financial and/or operational profile; 2) the planned expansion projects start generating the expected returns; 3) there is evidence of a stable and sustainable business profile for the company; and 4) there is an improvement in the group's complex structure and a relative strengthening of the Parent company's profile. The rating could see upward pressure once the company demonstrates a sustainable ability to maintain the following (consolidated) financial metrics on a consistent basis: CFO (less dividends)/Adjusted debt over 25% - 30%, Adjusted Debt/ EBITDA below 2.5x -- 3.0x, and EBIT interest coverage over 5.0x -- 6.5x.

What Could Change the Rating - Down

Conversely, the ratings could come under downward pressure if 1) Vedanta undertakes further acquisitions, investments or shareholder remuneration policies that sharply increase borrowings; and 2) it fails to satisfactorily execute its expansion projects. Credit metrics that Moody's would consider for a ratings downgrade include CFO (less dividends)/Adjusted Debt below 15%, Adjusted Debt to EBITDA exceeding 4x, or EBIT interest coverage declining to 3.5x or less on a sustained basis.

Rating Factors
[1]Vedanta Resources Plc

Mining Industry Factor 1: Reserves

a) Reserves (Years)

Aaa

Aa

A
X

Baa

Ba

Caa

Factor 2: Cost Efficiency & Profitability

a) EBIT Margin b) Return on Assets X X X X X X X X X X X Ba1

Factor 3: Financial Policies

a) Debt / Capital b) Debt / EBITDA

Factor 4: Financial Strength

a) Interest Coverage b) (CFO - Dividends) / Debt c) Free Cash Flow / Debt

Factor 5: Business Diversity & Size

a) Business Diversity Score b) Size

Factor 6: Other Liabilities Adjustments

a) Other Liabilities / Book Equity

Rating:
a) Indicated Rating from Methodology b) Actual Rating Assigned

[1] Based on 3 years average of FY2010A, FY2011E and FY2012E

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