We initiate coverage on Hindustan Zinc (HZL) with a Buy rating and a target price of Rs 1,490. Our positive investment case is premised on (i) aggressive capacity expansions making HZL a leader in the global zinc market with a volume CAGR (compound annual growth rate) of 18% over FY10-12, (ii) Deutsche Bank?s positive outlook for global zinc prices (CAGR of 16% over CY10-12), (iii) the company?s sustained low-cost positioning with captive access to high grade ore, and (iv) a strong net cash position, allowing HZL to pursue attractive inorganic growth opportunities, globally. We forecast Hindustan Zinc?s earnings to grow at a CAGR of 25% over FY10-12 with Ebitda (earnings before interest, taxes,depreciation and amortisation) margins expanding by 450 bps in FY12 to 58%. We rate the stock a Buy with a target price of Rs 1,490, implying 23% upside potential from current levels.
After sustained dominance of India?s domestic zinc market (94% of India?s zinc production in FY10), HZL is putting in place the strategic architecture to firmly establish its leadership on the global arena and achieve its vision of global-scale efficiencies. HZL is on track to take its combined zinc and lead capacity up to 1.064m tonnes by CY10?end, which would elevate it to the position of the world?s largest integrated zinc-lead producer. By virtue of its low-cost status (in both mining and smelting) and our positive outlook for global zinc prices, we expect the undergoing expansions in zinc to be highly value-accretive. Capacity expansion and stabilisation of new facilities are likely to drive a volume CAGR of 18% over FY10-12, resulting in earnings CAGR of 25%. Despite the recent outperformance of zinc with respect to other non-ferrous metals, we continue to believe that rising financial demand in the zinc market and improved supply- demand equation on account of production cuts and structural changes in consumption patterns in China could continue to provide support to global prices.
The foundations of Hindustan Zinc?s vision to create facilities of global scale rest on its core competency of low costs. A continued focus on costs and the strategic intent to be the world?s lowest-cost producer are among the pillars of HZL?s overriding business philosophy. Captive mining has allowed the company to sustain its low cost of operations and emerge as one of the most cost efficient producers of zinc globally, with an average Ebitda margin of 60% over the past five years. Cash costs for mining operations at two of its major mines, which constitute 54% of company?s total reserves, lie in the lowest quartile of the global cost curve. Nevertheless, we note that there has been an unexpected increase in operating costs in H1FY11, which we have incorporated in our forecasts.
The outlook for HZL?s key by-products?sulphuric acid and silver?has improved since the beginning of 2010. We believe the contribution of silver to HZL?s Ebitda is likely to increase to 16% in FY13 vs 7% in FY10 as production is ramped up at HZL?s silver-rich Sindesar Khud mine.
Risks: A sustained increase in the cost of production on account of deterioration in the grade of ore/higher stripping costs; profit-sharing proposal in new regulation by the government of India; risks related to environmental claims and damages/ regulatory approvals for new mines; appreciation of Re vs $.
?Deutsche Bank
