Macquarie Research:: Hindustan Zinc - 3Q result review- Best is priced in

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Hindustan Zinc
Best is priced in
Event
 3Q FY11 results – better than expected: Hindustan Zinc (HZ) reported 3Q
FY11 earnings that were better than expected on account of concentrate
sales during the quarter. The company has taken advantage of high prices,
but this is just preponing of profits, and our full-year profit estimates remain
unchanged. We believe that zinc prices have already peaked and that HZ is
richly valued at current levels. We recommend switching to the parent
company, Sterlite (STLT IN, Rs184, Outperform, TP: Rs216), which has
lagged HZ by 36% in the last six months. We maintain our Underperform
rating on HZ.

Impact
 Strong results – driven by higher zinc prices: Net sales at Rs26bn grew by
17% YoY, driven by a 12% increase in sales volume and 15% increase in
realisations. EBITDA was Rs14.8bn, which was up 9% YoY, and margins
recovered to 57% from 50% in the last quarter. Reported net profit grew by
12% YoY to Rs12.9bn, slightly helped by higher other income.
 Consensus – overestimating profits: Consensus forecasts are currently 4%
and 22% above our estimates for FY11 and FY12, respectively. We believe
that the Street is building in higher zinc prices, although we expect the surplus
in zinc markets to keep prices muted. We expect a downgrade in Street
estimates to put pressure the stock.
 Outlook on zinc: Our commodities team believes that zinc prices will remain
range-bound close to current levels. The marginal cost of production sits at
US$1,700–1,800/t, and the current oversupply situation does not justify
current high zinc prices. We believe that there is a limited upside from current
levels.
 Rising cash levels – opportunity or risk? The cash on HZ’s balance sheet
now stands at US$2.9bn, which is pulling down ROEs, and the company has
been unable to deploy this cash for growth. Sterlite recently acquired one of
Anglo’s mines, as HZ was unable to obtain required approvals on time. We
believe that the company’s growth potential is limited from current levels.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs1,150.00 based on a PER methodology.
 Catalyst: Delay in obtaining approvals and downgrades to estimates.
Action and recommendation
 Maintain Underperform: HZ is the most expensive zinc stock in our
coverage, trading at 11.6x FY12E PER, at a 43% premium to the peer group
average of 8.1x FY12. We continue to like Sterlite Industries and believe that
it is a better way to participate in the upside potential in earnings for HZ.