HINDUSTAN ZINC

Our commodities team has upgraded its zinc price forecasts, but believe that current zinc spot price has overshot the fundamentals and has downside risks. We downgrade the stock to Underperform from Outperform, even though we increase our target price to Rs1,029 from Rs996. Sterlite, the parent company, already owns a 65% stake and is very keen to exercise its option to buy an additional 30% stake from the government. While this should support a higher value, it is uncertain how the listing requirement of a minimum 10% free float is met. Moreover, the company has net cash of more than US$2bn. This is depressing the return on equity (ROE) to below 20%, in spite of the healthy operating margin of 60%+. Secondly, with management not very keen to distribute it as dividends, we see it as both risky and suboptimal use of funds. While we continue to like the low-cost assets, but believe that the risks are to the downside. Also, the uncertainty of the minority shareholders’ fate after the government stake purchase demands prudence at high valuations.