Hindustan Zinc Ltdcontent.indiainfoline.com/wc/research/research... · Hindustan Zinc Ltd 2 Zinc...

Sector: Metals & Mining

Sector view: Neutral

Sensex: 21,809

52 Week h/l (Rs): 142 /94

Market cap (Rscr) : 49,098

6m Avg vol (‘000Nos): 1,320

Bloomberg code: HZ IB

BSE code: 500188

NSE code: HINDZINC

FV (Rs): 2 Price as on Mar 14, 2014

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HZL Sensex

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Others Institutions Promoter

Change in Estimates Rating Target

Rating: BUYTarget (9‐12 months): Rs139CMP: Rs116Upside: 19.7%

Company Report March 18, 2014

Research Analyst: Tarang Bhanushali

[email protected]

Valuations compelling Zinc market tightness to continue The rise in Zinc prices has surprised us positively over the last one year and has outperformed other base metals during the same period. The tightness in the market was witnessed earlier than anticipated. We believe that the tight market condition in zinc global market would continue in 2014 as we estimate demand from the developed nations of US, Europe and Japan would be higher due to the on‐going monetary easing in the regions. This coupled with steady demand from China and India would lead to a strong recovery in zinc demand. As a result, we raise our zinc price estimates for FY15 and FY16 to US$1,950/ton from our earlier estimate of US$1,850/ton.

Mined metal output growth to resume in FY15E HZL’s 9M FY14 mined metal output has been a tad lower than our estimate. The underperformance was due to the change in its mining strategy from Open pit to Underground at Rampura Agucha and also due to a change in mining sequence wherein preference was given to primary mine development. We believe that the company’s mined metal output would increase with the ramp up of the underground mines at Rampura Agucha and higher contribution from the new mines at Zawar and Kayad. We expect mined metal output to increase to increase from 0.9mn tons in FY14 to 0.925mn tons in FY15 and 0.95mn tons in FY16. Valuations compelling; Maintain BUY We believe going ahead earnings for the company would receive a boost from the increase in mined metal output, firm zinc & lead prices and higher operational efficiencies. We expect HZL to witness earnings CAGR of 4.3% over the period FY13‐16 even on our assumption of a stronger rupee in FY16. At the CMP, the stock is trading at 6.4x P/E and 2.3x EV/EBIDTA on FY15E, which is lower than the range of its international peers. Current cash and cash equivalents of Rs240bn (48% of current mcap) is expected to rise to Rs370bn (75% of mcap). We believe downside from current levels is limited and maintain our BUY recommendation with a price target of Rs139.

Financial summary Y/e 31 Mar (Rs m) FY13 FY14E FY15E FY16E Revenues 126,998 139,535 147,710 151,439 yoy growth (%) 11.0 9.9 5.9 2.5 Operating profit 64,816 73,522 77,887 78,333 OPM (%) 51.0 52.7 52.7 51.7 Pre‐exceptional PAT 69,170 71,185 76,066 78,320 Reported PAT 68,995 71,185 76,066 78,320 yoy growth (%) 24.1 3.2 6.9 3.0 EPS (Rs) 16.4 16.8 18.0 18.5 P/E (x) 7.1 6.9 6.4 6.3 Price/Book (x) 1.5 1.3 1.1 1.0 EV/EBITDA (x) 4.2 3.1 2.3 1.5 RoE (%) 23.4 20.3 18.7 16.8 RoCE (%) 25.6 22.9 21.1 19.0

Source: Company, India Infoline Research

Hindustan Zinc Ltd

Hindustan Zinc Ltd

2

Zinc market tightness to push zinc prices higher Zinc prices have been in a downward trend since a peak of US$2,718/ton in January ’11 following subdued demand for metals globally. Prices largely remained below the US$2,000/ton level for most part of 2013. The 3‐month LME zinc price has largely traded between the range of US$1,800 and $2,000 per ton. However, prices have steadily moved higher over the last two months reaching a high of US$2,120/ton in March ‘14. The recent rally in zinc prices have been supported by the decline in mined metal output. The global zinc market after remaining in surplus state for six consecutive years (2007‐2012) turned into deficit in 2013. Adding to the bullish sentiment was the sharp decline in zinc inventory levels. Reported metal stocks, which had doubled over the period 2009‐2012, declined by 14% yoy in 2013. LME inventory levels over the year 2013 have declined by 23%. LME inventory levels have further declined by 20% in the first two months of 2014 fuelling the rally in zinc prices. Zinc prices have been in a downward trend since January ‘11

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Source: ILZSG, Bloomberg, India Infoline Research

The 3‐month LME zinc price has largely traded between the range of US$1,800 and $2,000 per ton, have steadily moved higher over the last two months reaching a high of US$2,120/ton in March ‘14

Zinc 3‐month LME prices have largely traded in the range of US$1,800‐2,000/ton in 2013

Zinc markets have turned into backwardation due to the tight spot market

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Hindustan Zinc Ltd

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Mined metal output growth was constrained at 1% yoy in 2013 due to closure of mines during the period. Zinc mined metal output was lower by 31.7% in Canada and 5.7% yoy in Australia. Output in Mexico too declined 3.6% yoy in 2013. Glencore reported a 12% yoy decline in its zinc mine production in Q3 2013 due to closure of its two big mines (Perseverance and Brunswick). The two mines are expected to reduce a total of 0.3mtpa from the world zinc supply. Refined metal production increased by 4.9% yoy to 13.1mn tons largely led by higher production in China and India.

Demand for the metal increased by 7.4% yoy to 13.2mn tons in 2013 on the back of strong demand growth witnessed in China and India. Refined metal usage increased by 13.7% yoy in China, followed by 12.2% yoy growth in India. After reporting a decline in zinc usage in 2012, demand increased by 4.6% yoy in US. Japan too showed a revival in demand in 2013 by registering a growth of 4.9% yoy. The European market remained lacklustre with usage rising by a mere 0.5% yoy. However, overall demand in Europe by lower by 5% from its peak in 2011. As a result of the growth in demand outpacing the growth in output in 2013, the zinc market turned into a deficit of 60,000 tons after remaining in the surplus state for six consecutive years.

Zinc mined metal output was lower by 31.7% in Canada and 5.7% yoy in Australia

Refined metal usage increased by 13.7% yoy in China, followed by 12.2% yoy growth in India

The growth in consumption outpaced the growth in production resulting into …

… 60,000 tons of deficit market in 2013

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Mine output growth stood at a mere 1% yoy in FY13 Mine production has declined since the closure of the two Canada mines in March

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Hindustan Zinc Ltd

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During the year, zinc producers are raising the premium they charge customers for refined metal as shortfall begins to emerge due to mine closures and strong Chinese demand. Premiums charges for delivery of zinc have risen to around US$180‐200/ton in FY14 from US$120‐130/ton last year. Large scale warrant cancellations have also led to lower availability of stocks in three Asian ports at the LME accredited warehouses for zinc storage, further fuelling the boost in premiums. Chinese demand for the material has been strengthening, as the world's second largest economy invests in new infrastructure such as airports and rail lines. Imports of refined zinc in China for 2013 increased by 16% yoy to 0.75mn tons from 0.65mn tons in 2012. Inventory levels at most of the warehouses have been in the downward trend raising premiums for spot delivery.

Premiums charges for delivery of zinc have risen to around US$180‐200/ton in FY14 from US$120‐130/ton last year

Zinc premiums have increased by end‐2013 due to tight market conditions

Lead premiums have slid since September ‘13

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Except for 2011, lead market has remained tight over the last six years

Lead market was in a deficit of 22,000 tons in 2013

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Hindustan Zinc Ltd

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Zinc mines closures during the period 2013‐1016

Company Mine Production ('000 tons) Closure year Country

Glencore Xstrata Brunswick 265 2013 Canada Glencore Xstrata Perseverance 135 2013 Canada Vedanta Lisheen 175 2014 Ireland MMG Century 515 2015 Australia Vedanta Skorpion 171 2016 Namibia Vedanta Black Mountain 37 2016 Namibia Others 281 Total 1,579

Source: ILZSG, Industry, Bloomberg, India Infoline Research

Inventory at LME warehouses has declined by 37.6% since December ‘12

… and at the Shanghai warehouses has declined by 32.5%

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Chinese zinc production has been strong at 10% yoy to 5.4mn tons (40% of global refined metal prodn)

Imports too have jumped 16% yoy in 2013

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Hindustan Zinc Ltd

6

We believe that the tight market condition in zinc would continue in 2014. We estimate demand from the developed nations of US, Europe and Japan would be higher on account of the on‐going monetary easing. This coupled with steady demand from China and India would lead to a strong recovery in global zinc demand. ILZSG expects global zinc metal demand to increase by 5% yoy in 2014 led by 7% yoy growth in China and 3.8% yoy growth in Europe. However, it expects demand in US to increase by a mere 1.2% yoy. Mine supply growth would remain low at 2% yoy in 2014 due to lower production from Canada, Finland and Ireland. Refined metal output growth is expected at 4.9% yoy led by strong output from India, Italy, Peru and Republic of Korea. With this estimates, we believe the zinc market would remain in the deficit state in 2014. On account of the tight market conditions, we expect the range for zinc prices to rise from the US$1,800‐2,000/ton to US$1,900‐2,200/ton. We raise our zinc price estimates for FY15 and FY16 to US$1,950/ton from our earlier estimate of US$1,850/ton. We expect Zinc and lead prices to improve over the next two years

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Zinc LME Lead LME


ILZSG expects global zinc metal demand to increase by 5% yoy in 2014 led by 7% yoy growth in China and 3.8% yoy growth in Europe On account of the tight market conditions, we expect the range for zinc prices to rise from the US$1,800‐2,000/ton to US$1,900‐2,200/ton

Zinc market to remain in deficit state in 2014 led by a revival in demand in the developed nations (‘000 tons) 2007 2008 2009 2010 2011 2012 2013 2014E

Mine Production 11,129 11,860 11,623 12,390 12,666 13,149 13,286 13,552

Metal Production 11,353 11,768 11,281 12,896 13,080 12,526 13,138 13,782 Metal Usage 11,347 11,559 10,915 12,649 12,706 12,290 13,198 13,858 Surplus/(deficit) 6 209 366 247 374 236 (60) (76)

Lead market deficit is expected to widen in 2014E (‘000 tons) 2007 2008 2009 2010 2011 2012 2013 2014E Mine Production 3,657 3,805 3,810 4,161 4,636 4,994 5,313 5,536 Metal Production 8,413 9,196 9,242 9,850 10,598 10,212 10,593 11,038 Metal Usage 8,421 9,188 9,245 9,815 10,444 10,154 10,615 11,103 Surplus/(deficit) (8) 8 (3) 35 154 58 (22) (65)


Hindustan Zinc Ltd

7

Mined metal output growth to resume in FY15E Mined metal output growth recovered in H2 FY13 due to higher production from the Sindesar Khurd and Rampura Agucha mines. However in 9M FY14, production at its largest mine Rampura Agucha has been lower due to the change in its mining strategy from Open pit to Underground. This impact of overall production has been offset by higher output from the small mines of Zawar and the ramp up at Sindesar Khurd mines. Q3 FY14 mined metal output was lower by 5.5% yoy by slower ramp‐up at its underground mines and due to a change in mining sequence wherein preference was given to primary mine development. As a result, the company lowered its FY14 guidance from 0.95mn tons of mined metal to 0.9mn tons. The company plans to increase its mined metal output to 1.2mtpa over the next five years. The annual capital expenditures for these projects are expected to be around US$250mn a year over the next six years. It comprises developing a 3.75mtpa underground mine at Rampura Agucha and expanding Sindesar Khurd mine from 2mtpa to 3.75mtpa, Zawar mines from 1.2mtpa to 5mtpa, Rajpura Dariba mine to 1.2mtpa and Kayad mine to 1mtpa.We believe that the company’s mined metal output would increase with the ramp up of the underground mines at Rampura Agucha and higher contribution from the new mines at Zawar and Kayad. We expect mined metal output to increase from 0.9mn tons in FY14 to 0.925mn tons in FY15 and 0.95mn tons in FY16.

Integrated metal output to jump in FY15 Integrated metal production is expected to increase over the next two years on the back of higher mined metal output. HZL after registering a decline of 11% yoy for FY13 in integrated metal production, has managed to pullback in 9M FY14 by registering a 17.4% yoy growth. We believe the growth momentum in integrated metal production would continue going ahead as mined metal output is expected to remain strong. We expect refined metal production to increase by 5.5% yoy to 0.92mn tons in FY15 and by 2.1% yoy to 0.94mn tons in FY16. The growth in refined metal production would be largely from lead metal.

Q3 FY14 mined metal output was lower by 5.5% yoy by slower ramp‐up at its underground mines and due to a change in mining sequence wherein preference was given to primary mine development We expect mined metal output to increase to increase from 0.9mn tons in FY14 to 0.925mn tons in FY15 and 0.95mn tons in FY16

Mined metal output was strong in H1 FY14 Mined metal output to increase 0.95mn tons in FY16E

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Hindustan Zinc Ltd

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Silver growth lower than expected Integrated silver production was lower than our estimate due to lower mined metal output from the Sindesar Khurd mine. The management was expecting integrated silver production to touch 400 tons in FY14 from 322 tons in FY13. They expected the growth to come from increase in output from Sindesar Khurd and increase in ore quality. However, integrated silver production has been lower than expectations in 9M FY14. The company has managed to register 18% yoy growth to 233 tons and has reduced the guidance for FY14 to 290‐300 tons of integrated silver production in FY14. We believe integrated silver production growth would remain subdued in FY15 and expect it to increase to 360 tons and 400 tons in FY16. Share of revenue from silver sales is expected to decline from 14.9% in FY13 to 9.4% in FY14. We believe that going ahead, this share would rise on account of an increase in silver production and a marginal hike in silver realisations.

We believe integrated silver production growth would remain subdued in FY15 and expect it to increase to 360 tons and 400 tons in FY16

Integrated metal production to jump 13% yoy in FY14E

Overall metal production is expected to increase by 5% yoy in FY15E

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Silver production to remain below capacity Share of silver of overall revenues to remain below FY13 levels

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Hindustan Zinc Ltd

9

Costs to decline from current levels HZL, over the last one year has witnessed a sharp increase in its costs on account of lower strip ratio, lower by‐product credits and an increase in consumption of imported coal. Cost of Production (CoP) has increased 15.8% over the period Q3 FY13 to Q3 FY14 on account of the above. We believe that CoP has peaked out in Q3 FY14 and would decline from here on due to higher volumes coupled with operational efficiencies. We also believe that by‐product prices have bottomed out and would marginally increase from current levels. Prices of international coal too are expected to remain flat over the next one year. However, the impact of lower CoP would be offset by a decline in spot metal product premiums. We believe with the changes in the LME warehousing rules spot premiums on metals would reduce in FY15. We expect OPM to remain flat at 52.7% in FY15 and then decline marginally in FY16 on our estimate of an appreciation in the rupee against the dollar. Led by strong volumes we expect operating profit to increase by 5.9% yoy to Rs77.8bn in FY15 and by 1% yoy to Rs78.3bn in FY16.

We expect OPM to remain flat at 52.7% in FY15 and then decline marginally in FY16 on our estimate of an appreciation in the rupee against the dollar

Quarterly revenue trend Revenue growth of 5.9% yoy would be largely led by higher volumes

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OPM has recovered in FY13 due to strong product premiums and higher mined metal output

OPM to remain flat in FY15E

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Hindustan Zinc Ltd

10

Cash per share to increase from Rs51 to Rs87 by end-FY16E HZL continues to generate huge free cash flow even though commodity prices remained weak during the year. Cash and cash equivalents increased at the end of Q3 FY14 stood at Rs240bn (~48% of current market cap). We believe that the company would continue to generate strong cash flow even after incurring the US$250mn yearly capex to expand its mining operations. We expect cash and cash equivalent to jump from Rs215bn at the end of FY13 to jump to Rs313bn by the end of FY15 and Rs370bn by the end of FY16. HZL announced a total dividend of Rs3.1/share for the year FY13, up from Rs2.4 in FY12. It has announced an interim dividend of Rs1.6 same as that of FY13. We expect the upward trend in dividends to continue going ahead as the company’s cash flow would remain robust.

We expect cash and cash equivalent to jump from Rs215bn at the end of FY13 to jump to Rs313bn by the end of FY15 and Rs370bn by the end of FY16

Cash and cash equivalent to jump to Rs313bn by end‐FY15E (63% of current market cap)

DPS to increase going ahead

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Hindustan Zinc Ltd

11

Valuations compelling; Maintain BUY HZL has managed to report earnings CAGR of 18.5% over the period FY11‐13 even though zinc prices have been lower by 10% and integrated metal production has remained flat over the same period. The growth in earnings has been largely led by the depreciation of the Rupee against the Dollar and an increase in silver production. We believe going ahead earnings for the company would receive a boost from the increase in mined metal output, firm zinc & lead metal prices and higher operational efficiencies. We believe that the tight market condition in zinc would continue in 2014. We estimate demand from the developed nations of US, Europe and Japan would be higher due to the on‐going monetary easing in the region. This coupled with steady demand from China and India would lead to a strong recovery in global zinc demand. On account of the tight market conditions, we expect the range for zinc prices to rise from the US$1,800‐2,000/ton to US$1,900‐2,200/ton. We raise our zinc price estimates for FY15 and FY16 to US$1,950/ton from our earlier estimate of US$1,850/ton. Over the next two years, earnings growth for the company would be led by higher volumes from the new lead smelter and mined metal output. The impact of higher zinc prices would be offset by lower silver sales volume and lower realisation. We expect HZL to witness earnings CAGR of 4.3% over the period FY13‐16 despite our assumption of a stronger rupee in FY16. At the CMP, the stock is trading at 6.4x P/E and 2.3x EV/EBIDTA on FY15E, which is lower than the range of its international peers. Current cash and cash equivalents of Rs240bn (48% of the current mcap) are expected to increase to Rs370bn (75% of mcap). We believe downside from current levels is limited and maintain our BUY recommendation with a price target of Rs139. Trading below its average 1‐year forward EV/EBIDTA

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Source: Company, India Infoline Research

Hindustan Zinc Ltd

12

Financials Income statement Y/e 31 Mar (Rs mn) FY13 FY14E FY15E FY16ERevenue 126,998 139,535 147,710 151,439Operating profit 64,816 73,522 77,887 78,333Depreciation (6,470) (7,745) (8,353) (9,264)Interest expense (291) (240) (240) (240)Other income 20,322 17,329 19,253 22,342Profit before tax 78,376 82,866 88,547 91,171Taxes (9,206) (11,681) (12,481) (12,851)Adj. profit 69,170 71,185 76,066 78,320Exceptional items (175) ‐ ‐ ‐Net profit 68,995 71,185 76,066 78,320

Balance sheet Y/e 31 Mar (Rs mn) FY13 FY14E FY15E FY16EEquity capital 8,451 8,451 8,451 8,451 Reserves 314,307 368,836 427,103 487,097 Net worth 322,757 377,286 435,554 495,547 Debt 4 ‐ ‐ ‐Deferred tax liab (net) 12,799 14,310 14,310 14,310 Total liabilities 335,560 391,596 449,863 509,857 Fixed assets 95,555 106,992 118,639 124,375 Investments 145,399 187,123 187,123 187,123 Net working capital 25,084 20,004 17,889 16,301Inventories 11,111 12,208 12,923 13,249Sundry debtors 4,029 4,426 4,686 4,804Other current assets 29,039 31,943 30,693 29,506Sundry creditors (4,842) (5,320) (5,632) (5,774)Other current liabilities (14,252) (23,253) (24,781) (25,485)Cash 69,522 77,477 126,212 182,058Total assets 335,560 391,596 449,863 509,857 Cash flow statement Y/e 31 Mar (Rs mn) FY13 FY14E FY15E FY16EProfit before tax 78,376 82,866 88,547 91,171Depreciation 6,470 7,745 8,353 9,264Tax paid (9,206) (11,681) (12,481) (12,851)Working capital ∆ (14,259) 5,080 2,115 1,588Operating cashflow 61,381 84,010 86,534 89,172Capital expenditure (12,919) (19,182) (20,000) (15,000)Free cash flow 48,462 64,829 66,534 74,172Equity raised 220 ‐ ‐ 0Investments (18,450) (41,724) ‐ ‐Debt financing/ disposal ‐ (4) ‐ ‐Dividends paid (15,270) (16,657) (17,799) (18,326)Other items (175) ‐ ‐ ‐Net ∆ in cash 14,787 6,444 48,735 55,846

Key ratios Y/e 31 Mar FY13 FY14E FY15E FY16EGrowth matrix (%) Revenue growth 11.0 9.9 5.9 2.5 Op profit growth 6.2 13.4 5.9 0.6 EBIT growth 11.8 5.6 6.8 3.0 Net profit growth 23.5 2.9 6.9 3.0 Profitability ratios (%) OPM 51.0 52.7 52.7 51.7 EBIT margin 61.9 59.6 60.1 60.4 Net profit margin 54.5 51.0 51.5 51.7 RoCE 25.6 22.9 21.1 19.0 RoNW 23.4 20.3 18.7 16.8 RoA 21.3 18.4 16.9 15.3 Per share ratios EPS 16.4 16.8 18.0 18.5 Dividend per share 3.1 3.4 3.6 3.7 Cash EPS 17.9 18.7 20.0 20.7 Book value per share 76.4 89.3 103.1 117.3 Valuation ratios P/E 7.1 6.9 6.4 6.3 P/CEPS 6.5 6.2 5.8 5.6 P/B 1.5 1.3 1.1 1.0 EV/EBIDTA 4.2 3.1 2.3 1.5 Payout (%) Dividend payout 22.1 23.4 23.4 23.4 Tax payout 11.7 14.1 14.1 14.1 Liquidity ratios Debtor days 12 12 12 12 Inventory days 32 32 32 32 Creditor days 14 14 14 14

Du‐Pont Analysis Y/e 31 Mar FY13 FY14E FY15E FY16ETax burden (x) 0.88 0.86 0.86 0.86Interest burden (x) 1.00 1.00 1.00 1.00EBIT margin (x) 0.62 0.60 0.60 0.60Asset turnover (x) 0.39 0.36 0.33 0.30Financial leverage (x) 1.10 1.11 1.11 1.10RoE (%) 23.4 20.3 18.7 16.8

Recommendation parameters for fundamental reports:

Buy – Absolute return of over +10%

Market Performer – Absolute return between ‐10% to +10%

Sell – Absolute return below ‐10%

Call Failure ‐ In case of a Buy report, if the stock falls 20% below the recommended price on a closing basis, unless otherwise specified by the analyst; or, in case of a Sell report, if the stock rises 20% above the recommended price on a closing basis, unless otherwise specified by the analyst

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