Stock Fundamentals. Hindustan Zinc: ‘Base’ still strong (Buy)

With the on-going trade tensions between the US and China, metal stocks, globally, have been under pressure over the last year.

In Hindustan Zinc’s case, loss of production due to transition from open pit mining to underground mining, coupled with market volatility, led to a fall in the company’s stock price by around 15 per cent since our last ‘buy’ call in April 2018.

However, a ramp-up of production in underground mining, zinc and lead deficit in the global market and the company’s near-monopoly in the domestic market will help it capitalise on the increasing demand for the metals.

At the current market price of ₹267, the stock is reasonably valued at about 13 times its trailing 12-month earnings, which is in line with the average for the past three years.

Also, the dividend yield of 7.5-9 per cent over the past couple of years makes it a good buying opportunity for investors with a high-risk appetite.

Deficit increases scope

Zinc accounts for 70 per cent of Hindustan Zinc’s overall revenues, with lead and silver contributing 15 per cent and 12 per cent respectively, in the first nine months of FY19.

The outlook for these metals is based on the function of international demand and supply factors.

As per the International Lead & Zinc Study Group estimates, global deficit for zinc and lead in 2018 was 3,84,000 tonnes (4,42,000 tonnes in 2017) and 98,000 tonnes (1,48,000 tonnes in 2017) respectively.

China’s (the world’s largest producer of Zinc) output for 2018 was 4.53 million tonnes — a fall of 4.6 per cent over 2017. This has been primarily due to the ongoing environmental crackdown in China, which is expected to continue. China’s steel production increased despite the ongoing US-China trade stand-off, supporting global zinc consumption.

Domestically too, the steel industry is expected to be healthy with an increase in demand in segments like pre-engineered buildings, general engineering, railway, and other government-aided infrastructure projects. The recent GST rate cut announced on real-estate projects too, should help revive consumer demand.

Further, the prices (at which sales are made) of these metals in the London Metal Exchange will take support from the supply shortage and depleted stocks. Last year, LME prices of zinc fell the most among all metals, by about 24 per cent and are now trading at $ 2,600-2,750 per tonne. This was largely due to the global trade tensions between China and the US than due to the metal-specific trade dynamics.

Experts believe that the zinc prices will rally to at least $3,000 per tonne going forward. If the trade agreement between China and the US is settled, the prices are expected to go beyond $3,500 per tonne.

Affected by transitioning from open pit mining to absolute underground mining, Hindustan Zinc’s production of zinc has fallen, while the share of lead and silver has increased since the beginning of FY19.

Ramping up production

Though the production in the current financial year is expected to be around one million tonne — flat compared to the previous fiscal — the management is confident of meeting the production target of 1.2 million tonnes by FY20, by ramping up mining activities and with the availability of better grades (high quality ore) from underground mining.

Further, increase in the production capacities will be from brownfield expansion projects. This is being planed in phases from 1.2 to 1.25 to 1.35 million tonnes per annum by digitising the mines and improving efficiencies of operations. Beyond 1.35 million tonnes, the company seeks new licences for mining operations, which is under progress.

Capex allocated for the expansion of mining operations and de-bottlenecking of capacities is $350 million for 2019.

In terms of increasing the operating profit, the company is also focussing on reducing the cost of production and increasing the share of value-added products such as silver and auto components.

Blip in operational performance

For the nine months of FY19, Hindustan Zinc’s revenue was ₹15,627 crore, down 1 per cent compared with the same period a year ago.

While zinc sales fell by 8 per cent Y-o-Y, sales of lead and silver increased by 20 per cent and 24 per cent Y-o-Y respectively. This was due to lower volumes and realisations of zinc and higher lead content in the mined ore production.

The company’s overall operating profit fell by 14 per cent to ₹6,568 crore due to increase in cost of production (CoP) in addition to lower realisations.

The CoP of zinc went up by 12 per cent Y-o-Y significantly due to rupee depreciation as two-thirds of the company’s costs are dollar-linked.

COMMENT NOW