Hindustan Zinc - A play more on fundamentals than delisting - SPA Securities

Our meeting with Hindustan Zinc (HZ) confirmed that things are on track and scope for negative surprises could be very limited. It is the mine expansion that HZ feels is challenging Vs smelter expansion. A smelter expansion can be easily executed, once the mines ramp up. HZ maintains 15% MIC growth in FY14. For 2Q14, MTM losses could arise on investment portfolio.

Weaker INR benefits, though volume off take could get impacted

For HZ, the revenue earned in USD is higher than its costs. For revenue, it is the selling prices (bench marked to LME) and for costs it is diesel, tyres, royalties and coal that are dollar denominated. HZ prefers to sell in domestic market as price charged to domestic consumer Vs exports is higher/protected due to 5% import duty. It generates 60-65% of revenues from domestic market and has 80- 85% market share in Zinc.

The contracts are more skewed towards the long term contracts than the spot. Prices, generally, under the long term contracts are decided monthly taking the LME average. A spot customer is likely to pay a higher premium Vs the long. According to HZ, INR weakness results in 60-65% net increase in bottom line.

The growth driver for Zinc is galvanized steel consumption. The slowdown in Steel consumption, April-Aug growth of 0.3% does not augur well for HZ's domestic market and may lead to some slowdown in domestic volume off take.

Cost savings from diesel, tyres to keep RAM's underground costs at par

Our apprehension that HZ's COP would rise once underground (UG) mining ramps up, have eased to some extent. RAM's (Rampura Agucha) current mining costs at USD 350 are 2.5-3x Vs 6-7 years ago. The increase has been due to higher strip ratios, higher diesel consumption, tyre and labour costs. Diesel's cost/ tonne of MIC is almost 1/3rd and continuance of open cast (OC) mining would have led to further cost escalations.

UG mining through a vertical shaft Vs current ramp mining with a depth of 1050 metre at both RAM & Sindeshar Khurd (SK) has been planned for USD 550mn. Once this comes on stream over next 4-4.5 years, HZ states that costs would largely be at par Vs current OC costs as diesel/tyre requirement would significantly reduce. Labor costs could be mixed as UG would require different skill sets, though count will be lower.

We understand that power costs (having visited Moil's UG Kandri mine)in UG mining through shaft are high ( i.e. carrying ore from the bottom of the pit to the top) due to those lifts, however HZ's captive power plant would keep power costs under control. We would opt to be little conservative and assume marginally higher costs, given that UG mining for HZ will be a new play ground.

Rules out special dividend, higher payout on cards

HZ's high cash on books and low scope on utilization has been a drag on overall ROE's. Given GOI's cash requirements, markets were expecting a special dividend. HZ has completely ruled out a case for any special dividend, however states that dividend payout could increase. HZ's investment portfolio mix is 15-20% in debt mutual funds, 60-65% in liquid/fixed maturity plans and balance in fixed deposits. We could see HZ reporting MTM losses for 2Q14 as >65-70% of the portfolio is under AFS category.

Outlook - play on fundamentals rather than delisting

HZ maintains its metal in concentrate (MIC) growth rate of 14-15% to a million tonne. Things that could go wrong for HZ could be the higher royalty likely to be charged and the MMRDA bill. On the macro front, HZ doesn't believe that mine depletion is an overplayed story. It states that mine closures > than incremental mine supply. In the metals set, HZ remains a strong play. Louder talks of GOI's stake sale increases the market belief about a possible delisting. We believe that delisting could take a longer time and therefore would refrain investors to buy on delisting story. HZ is currently trading at 4.2x EV/EBITDA (ttm).

Source : Equity Bulls

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