Hindustan Zinc: On solid ground

Pound WISE

Considering the firm price trend and a robust industry outlook, Hindustan Zinc's valuations seem attractive.

The entire commodity cycle including the non-ferrous metals industry has witnessed an upturn in the past couple of years. The bullishness continues to push up metal prices, which has led to strong performance of stocks in the metals segment.

While the recovery in aluminium and copper industries has been well documented and reflected in the stock prices of Hindalco, Nalco and Sterlite Industries, there are other stocks too which have benefitted immensely from the improved sentiments in the sector.

Hindustan Zinc (HZL), a leading player in the niche segments of non-ferrous metal industry such as zinc and lead has been among the biggest gainers in the metal sector in the past year. And going by analysts' opinion, the stock still provides a big opportunity for investors to cash in on the growth businesses of HZL.

The HZL stock has risen by 70.5 per cent in the past 12-months to Rs 212 levels. This is much better than the appreciation in stock prices of other biggies in the non-ferrous metal segment such as Hindalco (up 7.5 per cent), Nalco (down -0.4 per cent), and Sterlite Industries (37.10 per cent).

Also, Hindustan Zinc stock has given a return of 63.80 per cent since the beginning of 2004, while the corresponding rise in BSE Metals index is about 25 per cent. Analysts believe that there is still some steam left in the stock and are bullish about the company's business.

The runaway market leader
HZL, a group company of the Sterlite Industries, is the leading zinc manufacturer in India with about 90 per cent production share and around 80 per cent market share in the domestic market.

It is the only backward integrated domestic player and it's captive mines supply 100 per cent of its concentrate requirement. Its operations span through the entire value chain "� right from lead and zinc ore mining to smelting and refining. It has only one domestic competitor- Binani Industries (a non-integrated player) in the domestic market which has a capacity of 30000 tonnes (as on FY05).

Besides it is the only lead manufacturer in India, though lead forms a very small portion of total revenue (about 3.70 per cent in FY05). It also manufactures sulphuric acid and silver in small quantities.

Recently the company undertook expansions of mining and smelting capacity and installations of captive power plant (See table on capacity expansions). The capacity expansion places HZL in the league of top ten global zinc manufacturers. Analysts expect HZL's zinc production to satisfy the entire requirement of zinc in India.

Another thing going for HZL is the fact that it is one of the lowest cost producers of zinc in the world. And according to analysts, the cost advantage is only going to get better. The company's operating cost of zinc is expected to come down from $625/MT in FY05 to $550/MT in FY06. This can be attributed to the fact that the company is not only well insulated from raw material deficit on account of its captive mines, but power costs (the company has put up a 154 mw captive power plant) are also expected to be halved as a result of expansion.

Raw material and power costs form about 70 per cent of total operating costs. Thus margins are expected to expand substantially. The company is toying with the idea of going for another expansion plan of 170000 tons in January 2006, the benefits of which will accrue in FY09.

Price trends to remain firm
The firm trend in zinc prices is largely on account of the burgeoning demand from China. China's doubling of base metals consumption (including zinc) on account of its rapid industrialisation and increased demand from other emerging economies like India, Brazil, the Middle East and South East Asia led to a deficit of about 0.2 million tonnes in 2004.

In other words, while demand surged, existing mining capacities were inadequate to support this robust demand and hence the rise in prices.

Analysts note that the firm price trends are set to continue for a while yet. They are bullish about the outlook on zinc industry at least for next 2-3 years. According to analyst, Pritesh Vinay of Edelweiss Capital, LME zinc prices to increase from an average of $1140/MT in FY05 to $1320/MT in FY06E (up by 16 per cent) and $1390/MT in FY07E (up by about 5 per cent).

Global demand for zinc is expected to grow at 5-6 per cent over next few years and no significant mining capacity addition is expected. China is expected to be net refined zinc importer for 2005 and 2006. Galvanised steel (used in consumer durable, automobile and construction industry), which form about 47 per cent of the total zinc consumption is expected to be the largest consumers.

Domestic demand for zinc is expected to grow at 8-10 per cent over next few years on account of rapid growth of infrastructure development and India emerging as a major sourcing hub for galvanised sheets. However, even in the best case scenario, supply is expected to just about match demand and that too thanks to the capacity expansion by HZL.

Domestic prices of zinc are expected to follow the international trends as they are generally quoted at about 5 per cent discount to the landed costs. Recently, the company announced another hike of 6.30 per cent on zinc prices at Rs 78,300/tonne after a hike of 11 per cent last month (September).

Lead prices are also expected to remain firm going forward. Demand for lead is expected to grow at about 8 per cent in near future while supply is expected to be in deficit. This is because lead is a byproduct of zinc and therefore, the industry dynamics plays out much the same way. Automobile sector followed by chemicals and paints are expected to drive demand growth in lead.

Impressive financials
In FY05, HZL recorded a net sales growth of 18.80 per cent (y-o-y) to Rs 2187 crore. Operating and net profits also improved by 17 per cent and 61 per cent respectively. For Q1FY06, sales increased by 25 per cent. Operating and net profits increased by 14 per cent and 17 per cent respectively. 
 

FINANCIALS
(Rs crore)	FY05	FY04	%Chg	Q1FY06	Q1FY05	%Chg
Net sales	2187.00	1841.50	18.80	527.00	421.80	24.90
Operating profit	1018.00	868.10	17.30	240.00	210.70	13.90
OPM (%)	46.50	47.10	-	45.50	50.00	-
Adj Net profit	655.00	404.60	61.90	145.00	124.00	16.90
NPM(%)	29.90	22.00	-	27.50	29.40	-
EPS	15.50	9.60	61.50	3.44	2.93	17.40

However, there was a decline in operating and net margins during the quarter, due to the increase in raw material prices. Raw material prices were higher by 47.30 per cent in Q1FY06 as compared to 22.30 per cent in FY05. According to Vinay of Edelweiss Capital the company is expected to post a 30 per cent jump in both topline and bottomline between FY05-FY07.

Valuation
Hindustan zinc is quoting at a trailing P/E of 13.6x and about 10x FY06 estimates. HZL's current valuations are slightly on the higher side compared to peer group players like Hindalco (11x), and Nalco (8.67x).

However, analysts are quite optimistic about the prospects of the company and also think that the current valuations are quite reasonable as commodity cycle of zinc is still very attractive.