Hindustan Zinc Ltd (HZL) is the largest and only integrated zinc company in India with around 85% of the market share of India’s zinc market. It is also one of the lowest cost producers of zinc with good quality zinc mines and huge zinc reserves.

HZL has expanded its zinc capacity by 63% from 4.11lakh tonnes in FY2007 to 6.69lakh tonnes in April 2008, along with power capacity additions of 148.8MW during the same period.

It also plans to increase its Zinc and Lead capacity from 6.69lakh tonnes and 85,000 tonnes to 8.79lakh tonnes and 1.85lakh tonnes respectively by 2010.

Price correction

LME- Zinc prices have corrected by more than 50% in last couple of months and are currently hovering in the range of $1,000-1,100/tonne.

We believe that due to the expected surplus through 2008 and 2009, LME- Zinc prices will not rebound significantly from current levels.

However, downside is limited for shareholding pattern (%) the zinc prices, with 40-50% of the cost curve worldwide higher than the current LME prices.

Valuation

At Rs334, HZL is trading at 5.4x and 7.9x FY2009E and FY2010E earnings, respectively. However, it is trading at EV/EBIDTA of 1.6x and 1.8x FY2009E and FY2010E EBIDTA, respectively.

In the last downcycle (2002-2003) when the LME-Zinc prices were hovering in the range of $850-900/tonne, HZL traded at an average P/E of 3-4x and traded at EV/EBIDTA of 2-3x. Historically, the stock has been trading in a wide valuation band depending on the industry cycle.

Considering valuations of its global peers, on EV/EBIDTA, HZL is trading at a discount. However, we believe that HZL should trade on par with its efficient global peers on account of being one of the lowest cost producers of zinc.

We assign the down-cycle average EV/EBIDTA of 2.5x to HZL and arrive at a target price of Rs364. However, due to the weak zinc outlook going forward, an expected surplus in next 2 years and falling zinc prices and margins, we initiate coverage on the stock with a NEUTRAL recommendation.