Sunday, October 3, 2010

Hindustan Zinc

CMP Rs1,084, Target Rs1,277, Upside 17.8%

Hindustan Zinc Ltd (HZL) is one of the best bets among the metal companies on account of the integrated nature of its business and the volume growth over the next two years. While zinc prices have rebounded sharply (up 27% since June ’10) on the back of improved global economic sentiments and ample liquidity situation, HZL’s stock price has gained only 10% over the same period. It has underperformed not just the Sensex but also global zinc stocks (+15%). We believe that the underperformance is unjustified and the stock should trade at par with its international peers considering the size and integrated operations of the company. Also, based on our base case, we expect acquisition of Anglo American’s zinc assets to add Rs86/share to HZL’s fair value. Cash & equivalents at the end of Q1 FY11 stood at Rs123bn, representing 27% of the company’s current market cap. Even with our metal price assumptions, which are lower than the prevailing prices, we expect HZL to witness earnings CAGR of 15.1% over FY10-12E. We recommend a BUY rating on HZL for a target price of Rs1,277.

Zinc prices to remain range bound

We estimate zinc prices to remain range-bound in H2 2010. Major commodities will remain in a surplus state with the increase in supply overtaking demand. Attractive commodity prices have led to many idle capacities being restarted during the first half of 2010. However, metal demand has not returned to the 2008 levels. We estimate average zinc prices of US$2,000/ton in FY11 and US$2,100 in FY12.

Acquisition to increase capacity by 37%

HZL recently acquired Anglo American’s zinc asset portfolio for US$1.4bn. These assets produced 343,000 tons of zinc metal and 55,000 tons of lead metal. In CY09, blended cash costs for Anglo stood at US$1,148/ton. On a base case scenario, we assume 1) no cost reduction on account of HZL’s expertise 2) production volumes to remain constant and 3) zinc realisation of US$2,000/ton in FY11 and US$2,100/ton in FY12. We expect the acquisition to add 14.4% in FY11 and 15.1% in FY12 to the company’s earnings. The acquisition will be earnings accretive from the first year itself and will also provide higher returns (RoE of 17%) compared to the company’s treasury income (RoE of 5%) on its underlying cash.

Valuation summary
Y/e 31 Mar (Rs m) FY09 FY10 FY11E FY12E

Revenues 56,803 80,170 97,371 110,011

yoy growth (%) (27.9) 41.1 21.5 13.0

Operating profit 27,342 46,702 55,881 63,843

OPM (%) 48.1 58.3 57.4 58.0

Reported PAT 27,276 40,415 47,556 53,721

yoy growth (%) (38.0) 48.2 17.7 13.0

EPS (Rs) 64.6 95.7 112.6 127.1

P/E (x) 16.6 11.2 9.5 8.4

Price/Book (x) 3.1 2.5 2.0 1.7

EV/EBITDA (x) 13.0 7.2 5.2 3.7

RoE (%) 20.8 24.9 23.4 21.5

RoCE (%) 24.8 29.9 28.1 26.1


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