Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF) is by far the most undervalued stock in the FTSE 100 (INDEXFTSE:UKX). This is a bold claim to make, however, I believe that due to the nature of Vedanta’s corporate structure, many investors never fully understand the company’s value any its key metrics are often under reported.

Vedanta resources logo

Vedanta Resources currently a conglomerate

The reason for this is simple, Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF), in its corporate sense is currently a conglomerate, although it is waiting for final confirmation for it to merge entities together, the company is considered to be a holding company, as a result the earnings from its subsidiaries are not always taken into account.

Unfortunately, Vedanta is a basic materials company, a sector which is currently under a lot of pressure and out-of-favour with investors but I believe Vedanta’s low valuation and recent move into the oil business far outweigh the negatives.

However, before I get to the nature of the company’s operations, this is a quick overview of Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF)’s current valuation. At the end of Vedanta’s 2013 financial year, the company had $8 billion in cash, a current ratio of 1.3, total assets of $46 billion, debt of $16.6 billion, and liabilities stood at $41.5 billion. Net debt stood at $8.6 billion and shareholder equity was $4.4 billion, which equates to about £16 per share, 42% above the company’s current share price.

Vedanta attempts to improve production

Vedanta has been spending heavily over the past few years, like the majority of its peers to ramp up production in an attempt to take advantage of rising commodity prices. This strategy looks foolish now that commodity prices have fallen but Vedanta is not concerned.

You see, Vedanta recently brought out Cairn Energy PLC (LON:CNE) (OTCMKTS:CRNCY)’s – Cairn India, which counts its principle asset as a 175,000 barrel-per day oil field on Rajasthan. This acquisition was immediately earnings accretive and almost doubled Vedanta’s operating cash flow overnight. Furthermore, Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF)’s management notes that capital spending is set to fall over the next few years as the company’s projects reach inflection point. Indeed, Vedanta has been spending roughly $4 billion a year on CAPEX for the last four years and this is set to fall to $2 billion from 2013 onwards. The fall in CAPEX and Vedanta’s cash flow from Cairn India indicates that the company will actually be producing $1 billion in net cash a year, currently 30% of the company market cap. And 23% return on equity.

Free cash flow

In addition, Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF) is in the process of shifting its large debt pile onto its subsidiaries, which should free up a further $1 billion in interest costs every month, suggesting that Vedanta will be generating $1-$2 billion a year in free cash flow over the next few years – up to 50% of the group’s current market cap.

Still the company has an exposure to commodities and week commodity prices are bound to weigh on earnings. Having said that, after the acquisition of Cairn India, approximately 50% of Vedanta’s EBITDA now comes from the production of oil and gas, where it has a profit margin of 76%. In addition, during 2013, 5% of Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF)’s EBITDA came from the generation of power in India and this is an area of strong growth for both the company and the country as India’s electricity shortage is well known. Indeed, Vedanta has been spending heavily to try and take more of this highly lucrative and defensive market.

All in all, Vedanta Resources plc (LON:VED) (OTCMKTS:VDNRF) is a misunderstood company. While its roots lie in the commodity business, the company is now, for the most part, involved in the production of oil & gas, which gives the company a highly defensive nature. Moreover, the company has been sold off recently due to concerns over falling commodity prices and this pull-back presents an opportunity to invest in a cash generative company with a defensive nature that is trading below the value of its assets.