Hindustan Zinc

Falling cost of production, new capacity addition and huge cash reserve makes Hindustan Zinc a good medium-term bet
BASE metal prices have picked up over last six months, thanks to the improved optimism worldwide about a speedy economic recovery. But the road to recovery is paved with caution, and hence investors should cherry pick a stock from the base metal sector which offers good growth potential but with limited downside risk.

Hindustan Zinc is one such stock, which we recommended and predicted the bottoming out of zinc prices at that time. Since then, the stock price has more than doubled. Recently, the company reported a good quarterly result and is on track with its expansion plans. Its lower cost of production and huge cash and liquid investment reserve on its balance sheet makes it an attractive investment bet. Its new smelting capacity of 3 lakh tons, expected to be commissioned by mid-2010, is well timed with demand recovery. Mediumterm investors with a horizon of 2-3 years can add this stock to their portfolio.

BUSINESS

Hindustan Zinc is the largest zinc-lead producer in India with a market share of more than 80%. It is fully integrated having its own mines and power plants. The company’s total mining reserve and resources is estimated at around 272 million tonnes which contain different grades of zinc and lead content ranging from 5-13% and 1.5-3% respectively. It mines nearly 7 million tonnes of zinclead ore every year. Similarly, the company has smelting capacity of 0.75 million tonnes which operated at a capacity utilization of 80% in FY ‘09. In addition to these non-ferrous metals, it also produced around 105 tons of silver, which is a by-product of the core operation. It also sold around 1 million ton of sulphuric acid, a by-product, during same time period.

FINANCIALS

The company is one of the lowest cost zinc producers in the world, thanks to its raw material integration plan and better operating efficiency. Its operating margin, even in current market scenario, stands at more than 50%. Its average return on capital employed (ROCE) for last five years is close to 50%, much higher than many companies across different sectors. Hindustan Zinc has a target to bring down the cost of production to $550 per ton from the current sub $700 per ton level and that would further improve its operating margin substantially. It has a cash and cash equivalents of more than Rs 10,000 crore and zero debt on its balance sheet as on 31st March, 2009.

FUTURE GROWTH PLANS

The company plans to be one million tonne integrated lead-zinc producer in next two year time period. To achieve this target, the company is also expanding the capacities of different inputs like power and zinc-lead ore. It is setting up a power plant with a capacity of 160 MW and also increasing the mining capacity close to 10 million tonnes per annum. The silver production capacity would also increase to 500 tons per annum, from the current 150 tons per annum, boosting the profitability further since it is doesn’t add any further cost to main production process. The total investment required for this purpose is estimated at around Rs 3,600 crore which would be financed from internal accruals.

VALUATION

The company’s profitability in next two years would significantly increase because of lower cost of operation, higher volume and increase in realization. The impact of its additional 3 lakh tonnes capacity will be visible partly in FY ’11 and fully in FY ’12. The earning per share for FY ’11 and FY ’12 are worked out to be Rs 105 and Rs 135 respectively. At the current price level, this translates into forward price-earning (P/E) multiple of 6.9 and 5.4 respectively. This provides a significant upside potential for a stock, which traditionally trades at a P/E band of 10-14. Also its huge cash and cash equivalent on balance sheet translates into Rs 237 per share and limits the downward risk. Investors with a time horizon of 2-3 years can consider this stock for their portfolio.