Hindustan Zinc Ltd: ‘Silver to add shine’ - Annual Report Analysis

Hindustan Zinc Ltd (HZL) in its FY12 annual report highlights the expansion in its product making capacities, the accretion in reserves and its initiative towards green energy. In FY12, HZL managed to commission its 0.1mtpa lead smelter, 350tpa silver refinery and ramped up its mining capacity at Sindesar Khurd to 2mtpa. However during the year, grade of zinc metal in concentrate declined sharply from 13.09% to 11.98% at the Rampura Agucha mine (accounts for 88% of total mined metal). With the commissioning of the Phase II wind power projects, it has become one of India’s largest green energy producers. HZL is trading at its lower band (3.4x FY13 EV/EBIDTA), which we believe is a good entry point. We maintain our BUY rating on the stock with a revised 9-month price target of Rs137.

Costs to stay higher: Rising power costs & falling metal grades

HZL’s Cost of Production (CoP) has been on the rise over the last few years on account of increase in royalty, rising power costs and an increase in its strip ratio. We believe this would continue going ahead as Coal India has raised prices for non-power consumers and the strip ratio at Rampura Agucha is expected to remain high. However, the management expects the strip ratio to decline from H2 FY13. The impact of increase in costs would be offset by the jump in revenue from sale of silver. We expect OPM to expand 360bps yoy in FY13 to 56.8% from 53.2% in FY12. 

Valuations attractive; Silver to drive earnings

HZL over the last six months has commissioned the 0.1mtpa lead smelter in Dariba, the 350tpa silver refinery in Pant Nagar and has ramped-up of the SK mine from 1.5mtpa to 2.0mtpa. We believe this would play a pivotal role for the company over FY12-14E. We expect zinc and lead prices to stay subdued over the next two years as the market remains in an oversupply mode. However, the strength in the silver prices would boost margins for the company. HZL has been trading at a one year forward EV/EBITDA in the range of 3-8x for the past five years (Average one year forward EV/EBIDTA of 4.6x). We have taken a marginally lower multiple of 4.5x for our valuation, which is in line with the current weakness in the zinc cycle and sluggishness in demand. We maintain our BUY rating on the stock with a revised 9-month price target of Rs137.