Hindustan Zinc: Sound business at an attractive price

While higher return ratios, zero debt and huge cash in the books are positives, the company is also expanding capacities that will drive volumes and earnings, going ahead

 

The recent sell-off in the non-ferrous metals space, led by worries over global demand and realisation has thrown up an investment opportunity in the form of Hindustan Zinc. Although there are some short- term worries that the sector faces, Hindustan Zinc’s medium term prospects remain good, backed by a strong business model and valuations having turned attractive.

Hindustan Zinc’s share price has corrected from Rs 140 in January to Rs 120 currently. At current levels, it translates to a market capitalisation of over Rs 51,000 crore and PE of seven, based on estimated FY14 earnings.

Valuations look more attractive, given that the company is not only debt-free but also has huge cash and cash equivalent of Rs 19,300 crore (as of December 2012), almost Rs 46 per share or 38 per cent of its current share price. Excluding this, the core business PE works out to just 4.5 times, compelling for one of the world’s largest integrated and low-cost producers of zinc, lead and silver (its return on equity in the core business is a whopping 64 per cent).

  “Though, earnings over the next few quarters will remain steady, we maintain our positive stance on the company, given its attractive valuation, strong free cash flow generation and strong balance sheet with cash and cash equivalent of Rs 19,280 crore. Any positive development on the divestment of government’s stake could provide a boost,” says Jatin Damania, who tracks the company at SBICAP Securities. Some analysts have even upgraded the stock recently.

Kamlesh Bagmar, who tracks the company at Prabhudas Lilladher, said in a note, “Given the strong likelihood of stake sale at a much higher price and beaten-down valuations in terms of enterprise value to operating profits (Ebitda) at 3.4 times, based on FY14 estimated numbers, we upgrade the stock to ‘Buy’.”

In terms of business, absence of volume growth in the near term and lower LME zinc prices have impacted market sentiments. However, relative to aluminium and copper, zinc's fundamentals are considered better in terms of demand and supply. More important, the company is in the process of expanding its capacities, a part of which will go onstream by end-FY14, which will help boost growth in the long run.

“We believe that the next phase of growth for Hindustan Zinc will likely come from higher mining output and increase in silver volume,” says Damania.

The company is expanding its mining capacity with an annual capital expenditure of about $250 million or about Rs 1,400 crore over the next six years, totalling Rs 8,400 crore. Funding the capex should not be an issue, given the internal cash generation from operations of about Rs 4,500 crore (which is seen rising to about Rs 6,000 crore in FY14) and cash in the books.

Even after incurring the capex, Hindustan Zinc will be left with a higher cash kitty, which is good from the shareholder’s perspective in terms of dividends. The company plans to develop a 3.75-million-tonne (mt) underground mine at Rampura and intends to expand the Sindesar Khurd mine from two million tonnes to 3.75 mt. That apart, mining capacity at the Zawar mines will be increased from 1.2 mt to five mt. The benefits of these mines will start reflecting over the next two to three years.

Meanwhile, higher silver volumes and LME zinc prices will be crucial for growth. Currently, the LME zinc price is at around $1,900 a tonne and analysts expect it to be in the region of $2,000 a tonne in FY14 and FY15. Analysts expect the company’s zinc, lead and silver production to rise between 7-15 per cent in FY14, which should provide support to top line, and earnings to grow by 9-10 per cent.