Hindustan Zinc deal will be positive for Sterlite Industries

The buzz of government’s residual stake sale in Hindustan Zinc has lifted the share price of Sterlite Industries in the last fortnight. In fact, the last one week has seen a jump in volumes and five per cent gain in its share price. While LME metal prices have also gained partly aiding sentiments, analysts say there are good reasons to believe that the deal will be consummated, which will give Sterlite full control of Hindustan Zinc and reflect positively on its stock.

“With the government likely to announce market sale, Sterlite’s long wait to acquire government’s residual stake in Hindustan Zinc may be finally over. We believe the Hindustan Zinc’s offer for sale (OFS) will gather momentum now, as only few months are left to meet divestment target for FY13,” says Jagdishwar Toppo, who tracks the company at Axis Capital (earlier ENAM Securities).

This will be good news for Sterlite's shareholders as analysts believe that Sterlite, which holds 64.92 per cent in the Hindustan Zinc, will emerge much bigger and more importantly, it will give the company the much required freedom and capital.

It will also have a positive rub off on Sterlite’ valuations. Currently, the stake of Sterlite in Hindustan Zinc (worth Rs 37,700 crore) is valued at about 20-25 per cent discount (equivalent to about Rs 7,600 crore) to the market price of Hindustan Zinc, thanks to the holding company discount that the Street usually assigns to listed subsidiaries/investments.

However, if Hindustan Zinc is acquired fully, the discount will most likely be added to the overall valuations of Sterlite.

“As the company will hold 95 per cent in Hindustan Zinc post acquisition of residual stake, a holding company discount is unwarranted,” adds Toppo, who has removed the holding company discount of 20 per cent from his sum of part valuations (SOTP) to arrive at revised target price of Rs 113 (Rs 99 earlier).

In terms of freedom, too, it will allow faster decision making for Hindustan Zinc. Earlier, due to the delay in approvals, Hindustan Zinc could not complete the acquisition of Anglo Zinc assets. On the other hand, Hindustan Zinc has a strong balance sheet and is rich in resources.

The company has about Rs 19,000 crore worth of cash and cash equivalents in the books, which is 32 per cent of its market capitalisation. This is also a reason that analysts believe that before the expected sale, the company could announce a special dividend (government holds 29.5 per cent stake in the company worth about Rs 17,300 crore). Nevertheless, even for Sterlite it could deploy this cash more productively, yielding higher return on equity.