Hindustan Zine - Downgrade To Hold On Residual Stake Sale Overhang - Nirmal Bang

We have downgraded our rating on Hindustan Zinc (HZL) to Hold from Buy as we believe the deal of selling the residual 29.54% stake of the government to Sesa Sterlite would limit any material upside for minority shareholders from the CMP. Vedanta Resources, the parent of Sesa Sterlite, has offered a price of Rs149/share (just 11% up from the CMP) to the government for the residual stake. We would not like to go for the futile exercise of assigning a timeline to the deal as there are too many variables involved, but we believe the finance ministry would look at arriving at a consensus with the mines ministry for the deal to go through. We have raised our target price on HZL from Rs139 to Rs145 (4.5x FY15E EV/EBITDA) because of the increase in our EBITDA estimates to the tune of 5%/9% for FY14/FY15, respectively. However, as our revised TP is just 8% above the CMP, we have downgraded HZL to Hold from Buy.

HZL and Balco stake sale key for achieving India's fiscal deficit target: The finance ministry has budgeted Rs140bn of receipts from divestment of stake in non-government companies in FY14 Union Budget estimates (which included stake sale in HZL, Bharat Aluminium Company or Balco) and selling its investment in SUUTI (Specified Undertaking of UTI). Considering the slow process of its other divestment target of Rs400bn, the government would like the HZL and Balco deals to go through to meet its fiscal deficit target.

Too many variables involved with the deal: The government is still contemplating a route to sell its residual stake, which includes direct sale to Sesa Sterlite or offloading through an offer for sale (OFS). However, considering the uncertainty that would be faced by minority shareholders after the government's exit, we believe a large portion of the government's offering would have to be absorbed by Sesa Sterlite. Even if the deal goes through, there would be uncertainty regarding the treatment of minority shareholders - whether HZL would be merged with Sesa Sterlite or delisted from the stock exchanges. Considering the tedious process involved in changing the mining lease ownership, Sesa Sterlite may not prefer the merger route, which can dissolve HZL. In case it opts for delisting, Sesa Sterlite is likely to offer a price to the minority shareholders that is similar to what it offered to the government.

Government may prefer OFS route to avoid litigation on transaction value: Considering the growing ambit of the Comptroller & Auditor General of India (CAG), the government may choose the transparent OFS route to sell its stake in the open market in order to avoid any litigation over under valuation through negotiations. However, we believe the OFS route may not be very beneficial for minority shareholders as the transaction would normally happen at around the CMP.

Best business model in the metal sector: We continue to believe that HZL's business model offers the best potential from entities in our metal and mining coverage universe, but because of the stake sale overhang the best vehicle to play HZL is Sesa Sterlite.

Source : Equity Bulls

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