Stock Review: HINDUSTAN ZINC

ZINC prices have increased more than 6% in the past three months due to devaluation of the US dollar and higher imports from China, the world's largest zinc consumer.

The upside, however, will be limited in the nearterm due to higher London Metal Exchange inventory and supply glut. But that should not matter to the Indian zinc player Hindustan Zinc, which is likely to retain its margins, backed by expanded capacities.

Zinc inventory at the London warehouse is at a fiveyear high, reflecting more supply than what is needed to quench demand. Though the demand-supply scenario is unfavourable for zinc producers, prices of the base metal have firmed up mainly due to higher institutional purchases. This is reflected from the fact that prices of galvanised steel, which is the key end market for zinc, have not increased.

According to International Lead and Zinc Study Group, zinc supply is likely to remain in surplus of 160,000 tonnes in 2011. This excess of supply can keep prices of zinc in a tight range in the coming quarters. The stock of Hindustan Zinc, India's largest zinc producer and second globally, rose by over 18% in the past three months, following higher zinc prices. The company's sales grew by 20% in the September 2010 quarter, but operating margin suffered due to higher non-recurring employee cost and power expenses.

The company is expanding its Zinc production capacity by 10% and its mining capacity by around 40% by the end of March 2011. This augurs well, since it is the world's most efficient low-cost zinc and lead producer, with more than 50% of operating margin.

Another growth driver is the buoyancy in silver market. Hindustan Zinc produces silver and sulphuric acid as by-products. The zinc ore from its mines is rich with silver traces. Silver contributes just over 7% to operating profit before depreciation. This would jump to 16% once the company expands its silver production capacity by nearly three times to 500 tonnes in the next six quarters. The timing is perfect given that silver prices have increased by 58% in the past six months.

Hindustan Zinc's decision to acquire zinc assets of American miner Anglo American will help in securing future zinc reserves. The deal will make the Indian player the world's largest integrated zinc and lead producer, commanding 12% of global capacity.

At the current price, the stock is trading at 13 times its trailing twelve-month earnings, which is similar to its global zinc-producing peers such as Nyrstar. Given its expansion plans and better profitability, Hindustan Zinc may attract a better valuation in the future.