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Action: Lack of catalysts either way
HZ has been one of the better performing metal stocks during the past two
months (down 19.6% compared to the BSE metal index’s fall of 26.8%).
We believe the stock will have downside support on account of: 1) cash of
INR192bn and 2) earnings visibility. However, upside will likely be capped
as we expect: 1) earnings growth to taper since most of the expansion is
already completed and given higher royalties on account of new mines
and mineral acts and 2) we don’t expect yield on its cash and equivalents
to improve for lack of investment opportunities. Maintain NEUTRAL with a
target price of INR120.
Catalysts: Not in the immediate future
The sale of the remaining stake in HZ by the government would be a key
positive catalyst, in our view.
Valuations: Fairly valued, maintain NEUTRAL
We have valued HZ at 10x FY13E EPS of INR13. On our valuations the
stock would trade at 7.6x FY13E EV/EBITDA and 1.8x FY12E P/B. Since
cash contributes more than 35% of the total value, we believe there is a
strong support for the stock on the downside.
Although zinc prices have corrected by 16% during the past two
months, the impact was mitigated by a corresponding 10% depreciation
of INR.
We have reduced our target price to INR 120 from INR 130 earlier, as
our earnings estimates have come down due to higher royalties on
account of new mines and minerals bill.
Cash a key support – but lacks catalyst
HZ is amongst the best-performing metal stocks during the past two months (down
19.6% compared to the BSE Metal index down 26.8%), primarily on account of its strong
balance sheet and strong earnings visibility. Although zinc prices have corrected by 16%
during the same period, INR depreciation of 10% has mitigated the impact.
We expect zinc prices to start stabilizing at around USD2,000/t (down from our earlier
estimate of USD2,200/t), primarily because we expect slower zinc demand growth to
keep inventory at higher levels. At the same time, marginal cost has also come down,
due to lower treatment charges (TC) and depreciation of some of the zinc-producing
currencies.
We have lowered our earnings estimates by 1% in FY12 on account of lower zinc
realization estimates and 7.5% in FY13, primarily on account of higher royalties as
proposed by new mines and minerals bill (approved by the cabinet and to be presented
in the parliament in the winter session). We have also lowered our TP for HZ to
INR120/share (from INR 130 earlier) — we maintain our NEUTRAL rating on the stock.
Zinc price fall has been mitigated by rupee depreciation
Zinc prices have corrected by close to 16% from USD2,200 /t to USD1,860/t during the
past two months. However, the INR has depreciated by 10% during the same period.
Therefore, realizations for HZ have fallen by just 5-6%.
Indian zinc producers will be at an advantage, in our view, given that most of the other
major currencies have remained largely flat, while the INR has depreciated by close to
10% during the past two months. So while smelters/miners in other countries (Australia,
China and Peru) have seen 10-15% falls in revenues, HZ has seen just a 5-6% fall.
Zinc prices should find support at current prices
Close to 20% of the global smelters have turned unprofitable at contract TC, which is
USD40-50/t higher than spot prices (at spot TC almost 35% of the smelters will be
making losses, as per Brook Hunt ). Although most of the global miners are still profitable
on account of lower TC, we believe zinc supply will start to become strained as more and
more smelters come under pressure.
Although high inventory is a concern in the near term, we believe at zinc prices below
USD2,000/t, supply will start to be affected. Hence, zinc prices should average closer to
USD2,000/t, which is the marginal cost of production adjusted for currency depreciation
and lower TC.
Global zinc scenario
Stocks remain high – we expect balanced supplies
While stocks remain high, there is an improvement in the incremental demand-supply
scenario. The 2011 surplus is expected to shrink to 0.6mn tonnes from close to 1mn
tonnes in 2009 and 2010, as per our estimates. In terms of days of consumption, we
forecast inventory should peak in 2012 at close to 133 days, and then gradually come
down with the balanced demand-supply scenario.
We expect global zinc demand to grow by 4.5% in 2011 and 5.8% in 2012, down from
15.1% in 2010. Despite the strong recovery in 2010, US and European demand in 2011
would be 20% and 5% below its peak consumption in 2006, as per our estimates. China
remains the key demand driver, with consumption expected to grow at 10% in 2011 (1H
demand growth is close to 12% in China). Please note that we have built in 2% demand
growth in the US and -5% demand growth in Europe in 2011 on account of deteriorating
macro conditions. Even in China, we have built in slower growth going forward.
Although zinc production has remained in excess, the extent of surplus is narrowing and
we expect a better demand-supply balance going forward.
Cost curve suggests zinc price support at USD2,000/t – high
inventories a near-term concern
Cost curves, adjusted for the current exchange rates, suggest that even at a zinc price of
USD2,000/t, almost all the global miners are profitable on account of low treatment
charges (TC). At zinc prices of USD2,000/t, total TC will be close to USD220/t of
concentrate for the 2011 contracts, while on the spot market it has fallen to as low as
USD180-190/t. In China, imported concentrate is coming at a TC of as low as USD110-
120/t, against domestic concentrate at TC of USD160-180/t.
However close to 25% of the global smelters have turned unprofitable even at contract
TC (at spot TC almost 35% of the smelters will be making losses). Even for Chinese
smelters, higher Shanghai Exchange prices are being compensated for by lower
domestic TC. This is primarily because smelters have been hit by both lower zinc prices
and falling treatment charges.
Major zinc currencies i.e. RMB, AUD and the Peruvian Nuevo Sol have remained largely
flat against the USD, while the INR has depreciated by close to 8% during the past two
months. Zinc’s marginal cost of production has also shifted from USD2,100/t to
USD2,000/t on account of lower TC (so miners’ costs are lower).
We expect zinc prices to remain close to the marginal cost of production. We have
accordingly reduced our zinc price estimates for 2011 and 2012 to USD2,000/t.
Please note that zinc prices could face near-term pressures on account of high inventory
in the system. However, we don’t expect prices to be sustained at lower levels as we
believe most miners and smelters will turn unprofitable and hence supply will start to be
impacted.
Treatment charges (TC) should improve from current levels
Globally smelters have been hit hard both due to the fall in zinc prices (resulting in lower
revenues from free metal) and lower TC. As can be seen in the chart above, mining
production has lagged smelting production, resulting in falling TC. TC, which was above
USD140/t of concentrate in Nov 2010, has corrected to USD125/t in the spot market in
February. At the same time, 2011 contracts have been signed at USD230/t of base TC at
a base price of USD2500/t of zinc and price participation of 6% and -4%. At LME zinc
price of USD1,950/t, realized TC will be USD219/t of concentrate and total smelter
revenue will be close to USD705/t.
At the current spot TC of USD180/t of concentrate, smelter revenue will be close to
USD630/t and 35% of the smelters will be making losses, according to Brook Hunt
estimates.
Scenario analysis: What if the US and
Europe slip back into recession?
As the markets have been signaling that risks to our baseline forecasts are on the
downside, our global economics team have considered a bear case economic scenario,
most obviously triggered by a market meltdown, but the fragile state of the advanced
economies leaves them vulnerable to unforeseen shocks or policy errors. For details,
see Global Weekly Economic Monitor, 12 August 2011, and Global market turbulence:
Implications for Asia, 9 August 2011.
The bear case scenario assumes:
• The US and Euro area slip back into recession, with US GDP averaging -1% saar in
2H11 and Euro GDP averaging -3% before recovering to around 2% growth in 2012.
• The CRB commodity price index falls 15% between now and year-end, but starts rising
back again through 2012 reaching current levels by end-2012.
If there is a market meltdown and recessions in the US and euro area, we have no doubt
that initially many economies in the region would be hit hard again in an echo of the
global financial crisis, as non-linear effects start to kick in, notably financial decelerator
effects, multiplier effects of weakening exports on domestic capex and jobs, and capital
flight. However, less disturbing this time around are the two factors that there is less
leverage in the financial system (less room for capital flight) and less chance of Asian
trade finance drying up, as the world’s central banks have most likely learnt the need to
provide ample USD liquidity through FX swap arrangements.
In this scenario, we find Hong Kong, Singapore, Malaysia and Taiwan to be among the
most vulnerable. But, as in 2009, we would expect that, over time, powerful tailwinds
would develop, allowing Asia to bounce back before other regions. These tailwinds
include a likely further decline in commodity prices and the ample room Asia has to ease
monetary and fiscal policies – more so than any other region. In our bear case scenario,
we would expect the Fed to resort to further quantitative easing, which once again would
likely precipitate strong net capital inflows into Asia, attracted by stronger growth,
superior fundamentals and higher interest rates relative to other regions.
What if things get even worse than we can foresee? Although our global economics
team does not see such a situation as plausible at the moment, they have run an
extreme-case scenario analysis to provide some perspective. This extreme scenario
assumes:
• US GDP averaging about -4% saar in 2H11 and Euro GDP averaging -6.5% before
recovering to around 1% growth in 2012.
• CRB commodity price index falls 40% between now and year-end, and stays at the
lower level through 2012.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Action: Lack of catalysts either way
HZ has been one of the better performing metal stocks during the past two
months (down 19.6% compared to the BSE metal index’s fall of 26.8%).
We believe the stock will have downside support on account of: 1) cash of
INR192bn and 2) earnings visibility. However, upside will likely be capped
as we expect: 1) earnings growth to taper since most of the expansion is
already completed and given higher royalties on account of new mines
and mineral acts and 2) we don’t expect yield on its cash and equivalents
to improve for lack of investment opportunities. Maintain NEUTRAL with a
target price of INR120.
Catalysts: Not in the immediate future
The sale of the remaining stake in HZ by the government would be a key
positive catalyst, in our view.
Valuations: Fairly valued, maintain NEUTRAL
We have valued HZ at 10x FY13E EPS of INR13. On our valuations the
stock would trade at 7.6x FY13E EV/EBITDA and 1.8x FY12E P/B. Since
cash contributes more than 35% of the total value, we believe there is a
strong support for the stock on the downside.
Although zinc prices have corrected by 16% during the past two
months, the impact was mitigated by a corresponding 10% depreciation
of INR.
We have reduced our target price to INR 120 from INR 130 earlier, as
our earnings estimates have come down due to higher royalties on
account of new mines and minerals bill.
Cash a key support – but lacks catalyst
HZ is amongst the best-performing metal stocks during the past two months (down
19.6% compared to the BSE Metal index down 26.8%), primarily on account of its strong
balance sheet and strong earnings visibility. Although zinc prices have corrected by 16%
during the same period, INR depreciation of 10% has mitigated the impact.
We expect zinc prices to start stabilizing at around USD2,000/t (down from our earlier
estimate of USD2,200/t), primarily because we expect slower zinc demand growth to
keep inventory at higher levels. At the same time, marginal cost has also come down,
due to lower treatment charges (TC) and depreciation of some of the zinc-producing
currencies.
We have lowered our earnings estimates by 1% in FY12 on account of lower zinc
realization estimates and 7.5% in FY13, primarily on account of higher royalties as
proposed by new mines and minerals bill (approved by the cabinet and to be presented
in the parliament in the winter session). We have also lowered our TP for HZ to
INR120/share (from INR 130 earlier) — we maintain our NEUTRAL rating on the stock.
Zinc price fall has been mitigated by rupee depreciation
Zinc prices have corrected by close to 16% from USD2,200 /t to USD1,860/t during the
past two months. However, the INR has depreciated by 10% during the same period.
Therefore, realizations for HZ have fallen by just 5-6%.
Indian zinc producers will be at an advantage, in our view, given that most of the other
major currencies have remained largely flat, while the INR has depreciated by close to
10% during the past two months. So while smelters/miners in other countries (Australia,
China and Peru) have seen 10-15% falls in revenues, HZ has seen just a 5-6% fall.
Zinc prices should find support at current prices
Close to 20% of the global smelters have turned unprofitable at contract TC, which is
USD40-50/t higher than spot prices (at spot TC almost 35% of the smelters will be
making losses, as per Brook Hunt ). Although most of the global miners are still profitable
on account of lower TC, we believe zinc supply will start to become strained as more and
more smelters come under pressure.
Although high inventory is a concern in the near term, we believe at zinc prices below
USD2,000/t, supply will start to be affected. Hence, zinc prices should average closer to
USD2,000/t, which is the marginal cost of production adjusted for currency depreciation
and lower TC.
Global zinc scenario
Stocks remain high – we expect balanced supplies
While stocks remain high, there is an improvement in the incremental demand-supply
scenario. The 2011 surplus is expected to shrink to 0.6mn tonnes from close to 1mn
tonnes in 2009 and 2010, as per our estimates. In terms of days of consumption, we
forecast inventory should peak in 2012 at close to 133 days, and then gradually come
down with the balanced demand-supply scenario.
We expect global zinc demand to grow by 4.5% in 2011 and 5.8% in 2012, down from
15.1% in 2010. Despite the strong recovery in 2010, US and European demand in 2011
would be 20% and 5% below its peak consumption in 2006, as per our estimates. China
remains the key demand driver, with consumption expected to grow at 10% in 2011 (1H
demand growth is close to 12% in China). Please note that we have built in 2% demand
growth in the US and -5% demand growth in Europe in 2011 on account of deteriorating
macro conditions. Even in China, we have built in slower growth going forward.
Although zinc production has remained in excess, the extent of surplus is narrowing and
we expect a better demand-supply balance going forward.
Cost curve suggests zinc price support at USD2,000/t – high
inventories a near-term concern
Cost curves, adjusted for the current exchange rates, suggest that even at a zinc price of
USD2,000/t, almost all the global miners are profitable on account of low treatment
charges (TC). At zinc prices of USD2,000/t, total TC will be close to USD220/t of
concentrate for the 2011 contracts, while on the spot market it has fallen to as low as
USD180-190/t. In China, imported concentrate is coming at a TC of as low as USD110-
120/t, against domestic concentrate at TC of USD160-180/t.
However close to 25% of the global smelters have turned unprofitable even at contract
TC (at spot TC almost 35% of the smelters will be making losses). Even for Chinese
smelters, higher Shanghai Exchange prices are being compensated for by lower
domestic TC. This is primarily because smelters have been hit by both lower zinc prices
and falling treatment charges.
Major zinc currencies i.e. RMB, AUD and the Peruvian Nuevo Sol have remained largely
flat against the USD, while the INR has depreciated by close to 8% during the past two
months. Zinc’s marginal cost of production has also shifted from USD2,100/t to
USD2,000/t on account of lower TC (so miners’ costs are lower).
We expect zinc prices to remain close to the marginal cost of production. We have
accordingly reduced our zinc price estimates for 2011 and 2012 to USD2,000/t.
Please note that zinc prices could face near-term pressures on account of high inventory
in the system. However, we don’t expect prices to be sustained at lower levels as we
believe most miners and smelters will turn unprofitable and hence supply will start to be
impacted.
Treatment charges (TC) should improve from current levels
Globally smelters have been hit hard both due to the fall in zinc prices (resulting in lower
revenues from free metal) and lower TC. As can be seen in the chart above, mining
production has lagged smelting production, resulting in falling TC. TC, which was above
USD140/t of concentrate in Nov 2010, has corrected to USD125/t in the spot market in
February. At the same time, 2011 contracts have been signed at USD230/t of base TC at
a base price of USD2500/t of zinc and price participation of 6% and -4%. At LME zinc
price of USD1,950/t, realized TC will be USD219/t of concentrate and total smelter
revenue will be close to USD705/t.
At the current spot TC of USD180/t of concentrate, smelter revenue will be close to
USD630/t and 35% of the smelters will be making losses, according to Brook Hunt
estimates.
Scenario analysis: What if the US and
Europe slip back into recession?
As the markets have been signaling that risks to our baseline forecasts are on the
downside, our global economics team have considered a bear case economic scenario,
most obviously triggered by a market meltdown, but the fragile state of the advanced
economies leaves them vulnerable to unforeseen shocks or policy errors. For details,
see Global Weekly Economic Monitor, 12 August 2011, and Global market turbulence:
Implications for Asia, 9 August 2011.
The bear case scenario assumes:
• The US and Euro area slip back into recession, with US GDP averaging -1% saar in
2H11 and Euro GDP averaging -3% before recovering to around 2% growth in 2012.
• The CRB commodity price index falls 15% between now and year-end, but starts rising
back again through 2012 reaching current levels by end-2012.
If there is a market meltdown and recessions in the US and euro area, we have no doubt
that initially many economies in the region would be hit hard again in an echo of the
global financial crisis, as non-linear effects start to kick in, notably financial decelerator
effects, multiplier effects of weakening exports on domestic capex and jobs, and capital
flight. However, less disturbing this time around are the two factors that there is less
leverage in the financial system (less room for capital flight) and less chance of Asian
trade finance drying up, as the world’s central banks have most likely learnt the need to
provide ample USD liquidity through FX swap arrangements.
In this scenario, we find Hong Kong, Singapore, Malaysia and Taiwan to be among the
most vulnerable. But, as in 2009, we would expect that, over time, powerful tailwinds
would develop, allowing Asia to bounce back before other regions. These tailwinds
include a likely further decline in commodity prices and the ample room Asia has to ease
monetary and fiscal policies – more so than any other region. In our bear case scenario,
we would expect the Fed to resort to further quantitative easing, which once again would
likely precipitate strong net capital inflows into Asia, attracted by stronger growth,
superior fundamentals and higher interest rates relative to other regions.
What if things get even worse than we can foresee? Although our global economics
team does not see such a situation as plausible at the moment, they have run an
extreme-case scenario analysis to provide some perspective. This extreme scenario
assumes:
• US GDP averaging about -4% saar in 2H11 and Euro GDP averaging -6.5% before
recovering to around 1% growth in 2012.
• CRB commodity price index falls 40% between now and year-end, and stays at the
lower level through 2012.
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