The above title refers to Hindustan Zinc Ltd (HZL) in the context of Sesa Sterlite and Vedanta`s portfolio and in the context of Zinc as a commodity.
BUCKING THE TREND
While the commodity slowdown has been much discussed by this website, further research has shown that Zinc may be one of those commodities that may just buck the trend. While the China slowdown is imminent, and considering that China consumes more than 45% of global Zinc production, the chances of a Zinc bull run are slim. Nonetheless, issues relating to Zinc mine closures and labor strikes are significant and are expected to keep Zinc prices stable.
http://www.bnamericas.com/news/metals/teck-sees-zinc-rising-on-mine-closures1
http://online.wsj.com/articles/zinc-prices-surge-as-supplies-shrink-1403474976
To quote HZL`s 2013-14 Annual Report
” Century mine, Australia with 500,000 MT to close down in 2015. 160,000 MT Scorpion mine in Namibia closing in 2016 and 70,000 MT Poland mine closing in 2017 with 2.2 Million MT global capacity to be eliminated by 2019 “
Global consumption of Zinc currently stands at about 13 Million MT. 2.2 Million MT of eliminated capacity means a lot. Remember, Zinc is not shale oil or gas, which can be tapped ubiquitously by drilling a hole in the ground. Developing a greenfield mine is harder and takes more time. And this brings us to our protagonist.
HZL`S RESERVES AND PRODUCTION
HZL’s operations include five zinc lead mines, four zinc smelters, one lead smelter, one lead zinc smelter, seven sulphuric acid plants, a silver refinery plant and five captive power plants in the state of Rajasthan. In addition, HZL also has a rock-phosphate mine in Maton near Udaipur in Rajasthan and zinc, lead & silver processing and refining facilities in the state of Uttarakhand. The Company also has wind power plants in the State of Rajasthan, Gujarat, Karnataka, Tamilnadu and Maharashtra. (Source: Annual Report 2013-14)
HZL is the 2nd largest Zinc miner globally, 4th largest Zinc Lead metal producer globally, among the lowest cost producers of Zinc and has 1 Million+ MT integrated metal production capacity.
Click to access IMYB%202011_Lead%20&%20Zinc.pdf
At 880,000 tons of metal production (Lead + Zinc) per year and reserves of 35 Million MT of metal, HZL`s mines can run for more than 30 years at least.
The company`s Rampura-Agucha mine is the world`s biggest mine and has one of India`s highest metal content at 15.5%. HZL has smelter capacity (to convert ore to metal) of 1 Million MT and the company`s Chanderiya Lead Zinc smelter with a capacity of 610,000 tons is the world`s largest.
COST OF PRODUCTION
HZL`s cost of production with royalty is $ 1000/MT and $ 840/MT without royalty. With Zinc trading at $ 2200/MT, the company makes a margin of over $ 1000 per MT of Zinc sold.
FINANCIALS
For 2013-14, the company generated Rs 13,700 Crs of revenues (10,700 from Zinc, 2000 from Lead, 1600 from Silver, 180 from Wind minus the excise duty), Rs 8800 Crs of EBIDTA and Rs 7000 Crs of PAT. For a capital employed of Rs 12,000 Crs, the company easily hits RoCE`s above 50%. The company paid out a dividend of Rs 3.75/share for a Face Value of Rs 2/share.
MAT CREDIT
The company`s tax expense for 2013-14 was reduced by Rs 1000 Crs, thanks to MAT credit.
While I understand MAT and the credit (since companies may sometimes be liable for higher tax under MAT, due to book profits including reserves also), I would like readers to help me understand if such large credits are sustainable over longer time periods.
EXCELLENT FREE CASH FLOWS, NO DEBT
The company is sitting on a mountain of cash (Rs 25,500 Crs) and generates more than Rs 3000 Crs of free cash (after accounting for about Rs 3700 Crs of capital expenditure and dividend). Company is debt free.
CAPEX SPEND AND 2019 PROJECTION
Company projects spending $ 250 Million on mine development expenditure every year for the next 5 years and will hit metal output of 1.2 Million MT by 2019. Rampura-Agucha, the company`s flagship mine, will be converted from the current open cast to underground mining.
INDIA AND ZINC
India is the 3rd largest producer of Zinc with 6% of global production share. India`s share in world consumption of Zinc is 4.2%.
RAJASTHAN AND ROYALTY
All of the company`s operations are in the state of Rajasthan. The Vizag smelter was shut down sometime back. The company paid a royalty of Rs 1000 Crs in 2013-14. If I am right, then this royalty would have been pocketed by the state government of Rajasthan.
Click to access Exploring_India_Mining_the_opportunities_FINAL.pdf
An excerpt from the above E&Y report
” The maximum mining lease area was covered by Rajasthan (21%), Orissa (14%) and Karnataka (12%) ”
A business friendly government in Rajasthan and in Delhi should ensure that royalty payments are reasonable.
SHAREHOLDING
65% of Hindustan Zinc is owned by Sesa Sterlite. 59% of Sesa Sterlite is owned by Vedanta Resources UK and the promoter company holds 69% in Vedanta Resources. FII`s only hold 2% stake in HZL.
For those who are not aware, HZL was a government owned enterprise until 2000 after which the same was divested to Sesa/Vedanta. Initially, 26% was divested and Call Options were awarded to allow subsequent stake sales. While the other options have been exercised by Sesa, which is the reason why Sesa Sterlite has a 65% stake in HZL, the final Call Option is under litigation.
As per the above article, Sesa Sterlite is valuing HZL at $ 11 Bn (25% above initial offer price of $ 2.6 Bn for government`s 30% stake). From how I see it, Sesa is looking to make HZL a wholly owned subsidiary (by buying government stake, their shareholding goes up to 95%). With a current market cap of Rs 69,000 Crs or $ 11.5 Bn, Vedanta`s offer price to the government is just a tad higher than the market price.
Will the government accept Sesa Sterlite`s offer? I really doubt it. Indian markets are booming and HZL is trading at a puny P/E of 10 times. The government will be able to fetch a substantially higher price in the open market. Also, with the government running a deficit budget, there is no reason for them to sell HZL at current valuations to Vedanta.
DIVESTMENT SCAM
An investigation behind the initial divestment of HZL (in 2000) is ongoing. The charge is that the then government sold the 26% stake in HZL for an undervalued sum. How much of an effect will this have on the stock price? Tata Sponge was entangled in the coal scam during the time of this website`s recommendation. It went up by 4x.
COMPARISON WITH THE PARENT
Sesa Sterlite with a debt of Rs 35,000 Crs, market cap of Rs 68,000 Crs trades at a standalone P/E greater than 50x and a consolidated P/E of 7x. More importantly, it has a 17% FII holding. Sesa Sterlite`s business (which includes iron ore, copper, oil and gas) looks a lot less attractive than HZL. I believe that the only reason for low FII holding in HZL is the 5% free float (65% held by promoter and 30% by GOI).
VALUATION RATIONALE AND BUY RECOMMENDATION
The company makes more than $ 1000 per MT of Zinc sold. Zinc prices may correct, but I doubt if a bear rally will take hold of Zinc. Add to this the fact that the company is sitting on great reserves, tons of cash and no debt. Subtract the cash and we get a market cap of Rs 45,000 Crs for a company that makes a PAT of Rs 7000 Crs and margins above 50%.HZL is a great large cap value pick.
DISCLOSURE: I hold stake at current levels
thepokaranmoneymanager 