Hindustan Zinc Ltd (Q1 FY15)

Mined metal output remains impacted due to transformation of open cast to underground mining 

HZL’s mined metal output has been declining over the last one year as the company is transforming its operations at its largest mine, Rampura Agucha. Mined metal output for the quarter was at its lowest in the last four years. The company has indicated that output would be lower in H1 FY15 and would be ramped up in H2 FY15 as the output currently has higher percentage of waste. With the operations expected to touch the ore body in H2 FY15, mined metal output would be quite strong. Refined metal output too was quite lower during the quarter due to lower mined metal availability and maintenance shutdown. The impact of lower metal sales on topline was somewhat negated by higher metal prices and strong product premiums. Product premiums continued to gain on a qoq basis as spot market remained tight. Integrated silver production too was quite lower than expected.

Lower metal production led to a decline in operating profit

HZL’s operational performance was weaker than expected due to lower mined metal production and also on account of maintenance shutdown of one of its smelters. Operating profit for the quarter was lower by 10% yoy to Rs13.5bn, lower than our estimate of Rs16bn. Cost of production too increased on a qoq basis due to lower volumes, lower output from its open cast mines and a jump in mining costs due to higher amount of waste. The share of waste of total output was higher as the company is transforming into underground mining and it will take some time to reach to the ore body. CoP increased by 28.4% yoy and 8.3% qoq to Rs60,093/ton in Q1 FY15. In dollar terms, CoP excluding royalty increased by 20.2% yoy and 11.8% qoq to US$1,005/ton, highest in the last five years. By product realisations continued to remain subdued for the quarter and are expected to remain sideways in FY15.  The management expects cost of production to decline sharply in H2 FY15 on the back of higher volumes and higher mining yield.

Impact of lower operating profit was offset by a jump in other income

The impact of lower operational profit was more than offset by a strong qoq growth in other income. HZL reported a 21.9% qoq growth in other income to Rs7.2bn, higher than our estimate of Rs4bn. Effective tax rate for the quarter remained lower than the 15% guided earlier at 13%. PAT for the quarter stood at Rs16.2bn, higher than our estimate. The company had cash and cash equivalents of Rs262bn, out of which Rs221bn was invested in debt mutual funds, Rs20.5bn in bonds and Rs20bn in fixed deposits.

Valuation inexpensive; Maintain BUY

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. We have lowered our mined metal estimates for FY15 to factor in the sharp decline in volumes in Q1 FY15. However, we have maintained our FY16 volumes on expectations of a revival in H2 FY15. 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 5.1% over the period FY14-16E even on our assumption of a stronger rupee in FY16. At the CMP, the stock is trading at 8.6x P/E and 4.1x EV/EBIDTA on FY16E, which is lower than the range of its international peers. Current cash and cash equivalents of Rs262bn (36% of current mcap) is expected to rise to Rs366bn (53% of mcap). We maintain our BUY recommendation with a revised price target of Rs198.