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Sunday, January 18, 2009

Good Large Cap Stock in Metals - Hindustan Zinc (HZL)

Buy stock with Low-cost production, higher liquid investments, cash & bank balance and strong operational cash flows.

Beta 0.73
Institutional Holding 33.14%
Dividend Yield 1.4%
P/E 3.8
M Cap Rs 14,750 Cr
CMP 349


The prices of almost all nonferrous metals have declined to their multi-year low levels. At current prices, many global producers are either making losses or have shut down production. As per reports, the world’s zinc production has declined 30% and stock prices of these metal producers have also taken a hit. Though it is very difficult to find the exact bottom, prices of these commodities are close to their sustainable historic average of $1,000 (please refer the chart for detail). This is why we believe that the downside for zinc from here onwards is limited.

Hindustan Zinc (HZL), the largest integrated producer of the metal in the country, is one of the low-cost zinc producers, at around $750 a tonne, in the world. Such low-cost production, almost zero debt and high liquid investment, makes the stock, which has been more than halved from its peak, a very attractive buy. Long-term investors with a horizon of 2-3 years can add this stock to their portfolio.

BUSINESS:
HZL has its own mines, smelting capacity and power plants. The company’s total mining reserve and resources is estimated at around 225 million tones (MT), which contain 5-12% of zinc and 1.5-2% of lead. The company produces around 7 MT zinc and lead mine metal from its mines in Rajastan. Similarly, it has a smelting capacity of 0.75 MT and last year, the company operated at a capacity utilisation of around 65-70%. HZL also produces around 100-120 tonnes of silver, which is a by-product of the core operation. The company exports around 20-30% of its products to overseas destinations.

FINANCIALS:
HZL has significantly ramped up its operation after being acquired by Sterlite Industries in 2002. Net sales of the company have more than tripled over last three years, whereas net profit increased by more than seven times during the same time period. Its backward integration plan puts it on the top decimal of the lowcost zinc producers in the world. And, this has translated into superior operating margin. Its core operating margin rose to 75% in the financial year 2007, when the zinc prices were at their peaks. With the commodity prices falling, current operating margin has come down to around 50-55% level. Even if the prices fall by 20-30%, its operating margin will be maintained at around 30% much higher than many companies across industries. Its cash flow from operations is in sync with the movement in net profit over the last five years. HZL has very little debt outstanding, and hence, a very low debt-equity ratio of close to zero.

FUTURE GROWTH PLANS:
HZL aims to be the largest integrated zinc producer in the world and plans to augment its zinc and lead production capacity to around 1 MT by 2010. The company also plans to set up a 160 MW power plant and increase its mining capacity to 10 MT a year. Once, its production capacity increased, silver production would also rise to 500 tonnes a year, boosting its top line. The total investment required for this is estimated at around Rs 3,600 crore, which would be financed through internal accruals.

RISK:
The company bears less business and operational risk owing to the low-cost production, negligible debt and higher liquid investment and cash/bank balance. However, any drastic fall in zinc prices below $750 would significantly affect the company’s operating performance.

VALUATION:
HZL has huge liquid investments in debt funds, at around Rs 6,700 crore and cash/bank balance of around Rs 1,360 crore. The discounted cash flow from operations for the next four years and the sum-of-parts from investment and cash and bank balances yield a value of around Rs 14,000 crore, very close to current market capitalisation. We have taken into account of lower zinc prices and new capacities from mid-2010 while arriving at the future cash flows. However, we have not included the terminal cash flow, which would definitely add much more to it. Even in 2002-03 when the zinc prices were at the lowest level, the stock was trading at around 6-7 times of price-earning multiple compared to current P/E of 4. We believe the stock has good upside potential and investors with 2-3 years of horizon are advised to add it to their portfolio.
Source: Economic Times

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