Weighed down by high valuations

Hindustan Copper stock to be under pressure despite improving performance on high copper prices.

At a time when copper prices are ruling high and the financial performance of the integrated copper producer Hindustan Copper is improving, it’s surprising to see the stock price move down. The stock has also been underperforming the broader markets. It has halved from the high of Rs 610 in January.

In fact, there can be more surprises on the bourses for Hindustan Copper, which plans a follow-on public offer (FPO). Experts believe despite its improving prospects, there is room for the company’s share price to correct further as the current valuations remain high even as copper prices have gained 27 per cent over the last year and continue to rule firm.

High on low float
Hindustan Copper, in which the government holds a 99.59 per cent stake and only 0.26 per cent is public, has benefited from the lower free float in the market by way of relatively higher valuations. “Generally, the real discovery of prices only happens when there is enough float and liquidity in the counter,” says Ambareesh Baliga, vice-president, Karvy Stock Broking.

Currently, at about Rs 300, the market is valuing the company at Rs 27,983 crore. And, if the cash to the tune of Rs 173 crore (as on March 31, 2010) in the company’s books is deducted, this debt-free company is valued at 149 times its operating profits (Ebitda) and 21 times its sales based on the 2009-10 figures. Even on the price to earnings (PE) and book value (P/BV) basis, at 180 times and 25 times, respectively (based on 2009-10 figures), the stock is trading at a huge premium compared to its listed mining peers like NMDC, Coal India and Moil.

The year 2009-10 was not a good year for the company with subdued sales realisations and lower output vis-a-vis the previous year. Hence, this may not reflect a perfectly accurate picture. However, even if we assume that the company is able to yield higher realisations in its key revenue contributor, namely wire rods, in 2010-11 and thereafter, given the high copper prices, the EV/Ebitda works out to be well over 50 times.

What’s a realistic level?
Hindustan Copper filed its draft prospectus in September-end and is awaiting approval. Since current valuations appear high, at which the issue may find difficult to sail through smoothly, most market participants expect the FPO pricing to be significantly lower from the current levels.

While the final pricing hasn’t been announced, there are some indications. Consider this: The company wants to use the proceeds of the issue to invest Rs 1,032 crore for expansion, for which it will issue 92.5 million fresh shares. In addition, a similar number of shares will be in the form of an offer for sale from the government. This together translates into an FPO size of 185 million shares or Rs 2,064 crore (1,032 multiplied by two).

Purely based on these figures, the pricing could be in the region of Rs 100-120 a share or 60-66 per cent lower compared to the current price of Rs 300.

What do the experts say about the pricing? “I would not buy at Rs 300, but might consider at Rs 100 a share,” says Deven Choksey, CEO & MD, K R Choksey Shares & Securities. Arun Kejriwal, an investment expert, shares a similar view. “Looking at its expansion, the recent increase in copper prices and the copper supply constraints in the domestic market, at Rs 100 (a share) the pricing seems to be reasonable.”
 

EXPENSIVE VALUATIONS
	Hindustan Copper	Moil	Coal India	NMDC	Average*
PE (x)	322.5	10.3	17.4	15.9	14.5
M-cap/Sales (x)	23.8	5.4	3.7	9.6	6.2
EV/Ebitda (x)	153.1	5.5	9.8	9.9	8.4
All numbers are FY11 estimates. Hindustan Copper figures are based on annualised financials for 2010-11 except EV/ EBIDTA, which is based on FY10 numbers  * Average is for Moil, NMDC and Coal India                       Source: Capitaline, Analyst reports

The way forward
Hindustan Copper is a vertically integrated copper producing company as it manufactures copper right from the stage of mining to beneficiation, smelting, refining and casting of refined copper metal into downstream saleable products. The company has total reserves of 411.53 million tonnes (proved reserves of 187.95 million tonnes) and is estimated to command over two-thirds of the country’s copper ore reserves.

At the current rate of production, which is just 3.2 million tonnes, the reserves could last a little over 128 years. However, these estimates could change given the company’s plan to increase its production capacity to 12.41 million tonnes by the end of the financial year 2017, leading to a higher sales volume and profits in the coming years.

However, these are fairly long-term plans. For now, the company, which clocked revenues and a net profit of Rs 1,397 crore and Rs 155 crore, respectively, in 2009-10, could end 2010-11 with a significant rise in its net profit – it reported Rs 82.4 crore in the first half. Nevertheless, considering its near-term prospects, the current valuations are not justifiable.