Hindustan Copper: Pricing is key to success of FPO

Based on current valuations, experts say the stock is expensive and the expected offer will have to be priced at a discount

This year, the government will make its second attempt to divest part of its holding in Hindustan Copper Ltd through a follow-on public offering (FPO). In early 2011, the government had planned an FPO, but due to reasons like poor market conditions and valuations, the offer did not materialise. Though quite a lot of time has passed since then, both the issues still remain. The outlook for copper, which is its main business, remains weak, both in terms of demand and pricing.

For instance, while economic growth has been slowing, LME copper prices have corrected 13-14 per cent since April to about $7,330 a tonne presently. Besides, the current valuation of the stock (now at Rs 258.15) will also prove to be a hurdle given that it trades at almost 73 times its FY12 earnings.

In this context a lot will depend on the FPO pricing, which experts say will have to be at a substantial discount to the current market price. “The current price is high because of the low liquidity in the stock. However, looking at the valuations, I do not think there will be a buyer if the issue is priced at current levels. The government will have to give a huge discount to the current prices to bring the pricing in line with the acceptable valuations,” says Arun Kejriwal of Kejriwal Research and Investment.
 

EXPENSIVE VALUATIONS
FY12 Financials	Rs crore
Sales	1,484.29
Operating profit	618.51
Net profit	323.4
Valuation parameters
Current market cap	23,884.00
Cash and investments	597
Enterprise value (EV)	24,481.00
Mkt-cap / sales (x)	16.09
EV / Op. profit (x)	37.65
PE (x)	74
Source: CapitaLine Plus

Pricing: Key issue
Hindustan Copper has 925.21 million shares, of which the promoters (government of India) hold 99.59 per cent. The remaining 0.41 per cent or 3.798 million shares are held by other investors, including the public. Given this very low float in the market the price discovery is not efficient and, current prices do not reflect true valuations. At the current price of Rs 258, the company is available at Rs 23,884 crore. The company is debt-free, with cash in the books and investments totalling Rs 600 crore. Adju-sting for the same, the company’s value comes to Rs 23,284 crore.

Now, at this arrived value (Rs 23,284 crore), the company is available at more than 15 times its sales and 37 times its operating profit based on 2011-12 numbers. These valuations are significantly higher by any benchmark, both globally and domestically. Companies in the mining space are trading on an average at about five to six times their enterprise value (market capitalisation plus debt) to operating profit.

During its last attempt to launch an FPO, analysts were expecting the issue to be priced at around Rs 100 a share. Also, at that time, the company intended to invest about Rs 1,032 crore in expansion projects, for which it was supposed to issue 92.5 million fresh shares. Besides, a similar number of shares were earmarked towards offer for sale by the government. Based on this, the size of the issue was estimated at around Rs 2,000 crore.

This time though, and given its cash rich status, the company is unlikely to participate. Nevertheless, pricing will be crucial. Experts say that at around Rs 100 per share, the price to earnings multiple will work out to 23 times and enterprise value to operating profit at 14 times, which is still reasonable given, its reserves. If the pricing is done in that region, the existing share price in the secondary market will correct in line with the issue prices, which are yet to be decided.

Production scale-up
Hindustan Copper is a leading player in the domestic copper industry and is the only vertically integrated copper producer in India engaged in a wide spectrum of activities, ranging from mining to beneficiation, smelting and refining. The company has done well in the recent past with March 2012 quarter sales nearly doubling to Rs 585.6 crore and net profit surging 125 per cent to Rs 137.4 crore, compared to the year ago quarter. For the full year (FY12), too, net sales grew 27.3 per cent to Rs 1,484 crore, while net profit jumped 44.3 per cent to Rs 323.4 crore, the highest ever.

The company’s long-term prospects look good given its total reserves of 412 million tonnes, about two-thirds of India’s copper ore reserves. These are huge reserves compared to the current production of about 3.6 million tonnes. While the reserves are huge, future growth will depend both on the pricing environment and the increase in production.

While pricing will depend on the global environment, the company is taking measures to augment its mining capacity by increasing production from the existing mines and by developing new ore reserves, besides re-opening closed mines. “It has prepared a detailed road map to increase production of ore from the current level of 3.6 million tonnes to approximately 12.41 million tonnes per annum by end of fiscal 2017,” stated its FY11 annual report.

While this will help sustain long-term growth, based on the targets it translates to about 28 per cent annual growth in production, which is ambitious and needs to be monitored. Nevertheless, FY17 is still far away and gains in the near to medium term will continue to depend on the sector’s dynamics.