Metal price decline casts shadow on Hindustan Zinc's prospects

Though volumes are growing, the fall in silver, zinc and lead prices will hurt the company's earnings

The Hindustan Zinc Ltd (HZL) stock has recently come under fresh pressure after the slide in global prices of silver, zinc and lead. On Wednesday, the stock fell to its 35-month low before closing at Rs 97.90, taking the total decline in the month of June to 15.6 per cent. Earlier in April, the stock had fallen to its 52-week low of Rs 107 on the back of weak metal prices and overhang of stake divestment by the government. However, it rose to Rs 124 levels in May, helped by a strong performance in the March  quarter. Analysts had also hoped that rising volumes in silver would offset a large part of the weakness in metal prices. However, now, with silver prices showing no signs of bottoming and zinc and lead prices near their recent lows, concerns have cropped up again. Analysts, thus, expect the company’s earnings to remain muted in FY14 and FY15. In fact, looking at the weak market sentiments, they are not ruling out further pressure on the stock in the near term.

Weak metal prices add to worries
Global silver prices, which averaged $30 an ounce in FY13 and around $28 an ounce at the start of the June quarter, have slid below $20 an ounce at the end of the June 2013 quarter. Analysts at HSBC have already tweaked their average silver price estimates from $30 an ounce in FY13 to $23 an ounce in FY14. With silver prices currently hovering around $18, other analysts are not ruling out further weakness.

Additionally, zinc and lead prices remain weak. The average zinc price in the June quarter is about $100 lower than the average FY13 price of about $1,950 a tonne. Lead prices are also under pressure. Going ahead, analysts expect average zinc prices to hover around $1,950-1,980 a tonne and to cross $2,200-$2,300 levels only around FY15. For lead, they expect prices to remain at similar or slightly lower levels of $2,111 a tonne seen in FY13.

Volumes to provide some support
On the flip side, the company is seeing improvement in volumes. The company’s SK mine, which had seen a decline in mined metal output in the first half of FY13 leading to lower production of zinc (153,000 tonnes each in the first two quarters of FY13), has seen higher production thereafter. Thus, zinc production increased to 168,000 tonnes and 181,000 tonnes in the quarter ending December 2012 and March 2013, respectively. Silver production also increased to 100 tonnes in the March 2013 quarter from 62 tonnes in the December 2012 quarter, taking the total production to 321 tonnes in FY13, an increase of 35 per cent over 237 tonnes in FY12.

For FY14, the company has guided for a 15 per cent growth in mined metal production to one million tonnes on the back of increased output from the Zawar, SK and Kayar mines. The net saleable silver production (after accounting for own consumption) is guided to grow 25 per cent year-on-year to 360 tonnes (analysts see it achieving 350-360 tonnes) from 288 tonnes in FY13. Among key monitorables is the grade of silver reserves at SK mine, which fell to 146 gm/tonne in FY13 from 161 gm/tonne in FY12. Analysts at Kotak Securities say this may not have a negative impact on current production levels, but point out that a further decline in grades can put a cap on potential increase in silver volumes.

Valuations
Overall, though volumes are growing, in a report dated June 20, analysts at HSBC have lowered their Ebitda estimates for the company by eight per cent and two per cent for FY14 and FY15, respectively, considering lower silver, zinc and lead prices. The muted earnings outlook will keep up pressure on the stock in the near term.

However, a majority of analysts believe there is value in the stock. Among reasons for this belief are low valuations, debt-free status and intrinsic worth of the assets held by the company. A weak rupee is also expected to provide support to realisations. While HSBC analysts value HZL at Rs 150 per share based on a FY15 enterprise value (EV)/Ebitda of five times, those at Kotak Securities have a target price of Rs 150. According to Bloomberg data, of the 18 analysts’ recommendations made in June, 17 have ‘buy’ calls on the stock and one an ‘accumulate’ — the target prices range Rs 125-164.