Hindustan Zinc - A better play on non-ferrous metals than Hindalco - Angel Broking

Prices of non-ferrous metals (alongside non-ferrous stocks) have declined steeply over the past one year on the back of escalating sovereign debt crisis in Europe. Prices of aluminium and zinc are below the cost of production for several smelters around the world. Several big players such as Rio Tinto and Alcoa have already announced production cuts over the past six months. Hence, we do not expect current levels of base metal prices to sustain over the medium term. In light of the anticipated increase in the prices of base metals, we analyzed the likely impact on the stock-price performances of Hindalco and Hindustan Zinc (HZL).

Hindalco's stock performance is likely to be determined by the timely commencement of its upcoming projects, timely development of captive assets and the movement in aluminium prices in our view. We believe Hindalco stock's correlation with LME aluminium prices (in INR terms) will remain lower than historical levels. On the other hand, with a strong balance sheet, low capex requirements, 12% CAGR in EPS over FY2012-14E and compelling valuations, we believe HZL is an attractive bet at current price levels. Moreover, with a strong correlation (83%) between aluminium and zinc prices, we believe HZL is a better way to play upside in base metal prices. Valuing the stock at 4.0x FY2014 EV/EBITDA, we recommend Buy on HZL with a target price of Rs.141 while we maintain our Neutral rating on Hindalco.

Hindalco's upcoming projects continue to face delays: As highlighted in our report on Hindalco dated June 13, 2012 (Hindalco - project delays ahead), we anticipate project delays alongside lower profitability from its aluminium business during FY2013-14. On June 26, 2012, Hindalco announced that it had delayed commissioning of Mahan smelter (earlier scheduled to commission during 1QFY2013), in-line with our expectations.

Hindalco - No longer a 100% proxy for aluminium prices: Hindalco's stock had a strong correlation with INR-denominated LME aluminium prices since the past 22 years. However, over the past one year, this correlation has dropped significantly mainly on account of project delays. Further, with massive aluminium capacity expansion ahead, we believe stock performance will be determined by the timely commencement of these projects, timely development of captive assets and the movement in spot aluminium prices. Hence, Hindalco will no longer be a 100% proxy on aluminium prices over the coming 2-3 years in our view.

Zinc and aluminium metals have high correlation: Although zinc and aluminium metals have different demand-supply dynamics and cost structures, there is high correlation between the prices of both these metals. The correlation between zinc and aluminium prices since the past 20 years has been 83%. Even over the past one year, zinc and aluminium prices have witnessed declines of similar quantum with zinc and aluminium prices declining by 23% and 25%, respectively. Hence, we believe any rise in aluminium prices hereon should also be accompanied by an increase in zinc prices and vice versa. Hence, we prefer to bet on HZL over Hindalco.

Source : Equity Bulls

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