Hindustan Zinc

Investors can consider buying the shares of Hindustan Zinc, subsidiary of Sterlite Industries, given the company's dominant position in domestic user industries. This is supported by the fact that steel production volumes are beginning to increase and that the automotive and consumer durables segments too are witnessing a ramp-up.



In addition, the company is trying to take the inorganic route to expansion and gaining access to mines.

At Rs 965, the company trades at an attractive valuation of just over 10 times its FY10 per-share earnings. This is at a discount to most global peers. However, given the current weakness in most metal stocks, investors can consider accumulating the stock on dips.

THE BUSINESS

Hindustan Zinc owns and operates four mines and four metal extraction smelters in India. Smelting is the process by which a metal in its impure ore form is converted into pure usable form. The company's domestic resources indicate around eight to nine million tonnes of zinc and under two million tonnes of lead.

The company produced just under 5,80,000 tonnes of zinc metal in FY10. This is in addition to producing 70,000 tonnes of lead and 1,76,000 tonnes of silver. The user industries for zinc include steel (for galvanising), automotive and consumer electronics, paints, batteries and sheets. Recent additions of over a million tonnes of smelting capacity and estimated utilisation levels of 85 per cent prior to expansion indicate significant scope for domestic volume-led growth.

Lead's main user industry is industrial battery manufacturers. The company's net sales and net profits have grown at a compounded annual rate of 20 and 28.7 per cent, respectively, since FY06. The company's key strengths are its highly integrated business model — with access to high quality mines, smelters in close proximity and captive power for the energy gobbling smelters.

Being among the lowest cost producers of zinc, the company has operated on net profit margins of over 48 per cent since FY06. In FY10, Hindustan Zinc generated revenues of Rs 8,017 crore and net profits of Rs 4,041 crore.

Acquisitions

The company's recent $1.33-billion acquisition of Anglo American's zinc assets in Europe and Africa has upped its zinc metal reserves by 37 per cent. The acquisition gives Hindustan Zinc a significant presence in Africa through the Skorpion mines in Namibia and yet-to-be operationalised Gamsberg mines in South Africa. The latter is expected to contribute over 10 million tonnes of zinc to be tapped over 20 years. The existing operational mines in Ireland and Namibia are earnings-accretive and expected to add 3,50,000 tonnes of zinc metal production capacity.

The acquisition is expected to be funded by the Rs11,900 crore in cash the company has. The company has negligible debt on its books.

THE MARKETS

Around 50 percent of the demand for zinc is to galvanise steel to prevent corrosion. India's current steel production capacity stands at 65 million tonnes. This number is expected to rise to 100 million tonnes by FY13. Consumer durables and automotive products are the largest consumers of galvanised steel.

Both sectors have registered a scorching pace of growth over the last year, with IIP numbers indicating strong growth in Consumer Durables over the last one year. In the case of automobiles, SIAM numbers for the April-May 2010 period registered a scorching 33.5 per cent growth over the same period last year.

GLOBAL REALISATIONS

The International Lead and Zinc Study Group has projected a supply overhang of 4,00,000 tonnes of zinc in 2010. Global zinc production is expected to stand at 12.45 million tonnes in 2010, against projected demand of 12.04 million tonnes. Inventory levels at the London Metal Exchange estimated at a five-year high level of 6,17,000 tonnes. However reports indicate if Chinese warehouse levels are included the number is closer to one million tonnes.

Near-term realisations are likely to remain under pressure due to a combination of lower Chinese demand and Euro-zone worries. In the medium term, if zinc prices head further south from the current $1,700 levels, they will enter lower-than-the-production cost territory for several high-cost producers. Zinc majors are likely to make production cuts and smelter shutdowns in an effort to support prices.

Even during periods of low realisations such as the quarters ended December 2008 and March 2009, Hindustan Zinc turned in net profit margins of 35.7 and 43.6 per cent. All of the above has provided the company with an enormous buffer zone of profitability in an industry where pricing power is very limited.

THE RISKS

South African mining company Exxaro has a 26 per cent stake in the Gamsberg mine and has the rights to match Vedanta's bid for the mine. However with media reports indicating that Exxaro is looking to exit the zinc mining business, the latter risk may not be a major concern.

via BL