Hindustan Zinc’s shares wilt under rising cost outlook
Since 17 January, the Hindustan Zinc Ltd (HZL) stock has fallen 9% even as zinc prices have remained firm. A gradual but sustained increase in production costs is turning into a worry. After its FY17 results, the company had said it expects the cost of production to be $830/tonne in FY18. This was revised after the September quarter results to $900-950/tonne but now it has been revised again to $950-975/tonne.
The main reason is an increase in prices of commodities such as coal, metcoke and fuel. Also, HZL was expecting to procure coal through the linkage mechanism but did not get any during the December quarter, as linkage coal was diverted for power generation. The management said linkage coal has begun to land and it expects to meet around 20% of its requirement from this source, and then increase this level further in FY19.
While the linkage component may see HZL’s blended cost moderate, the increase in the base commodity prices could see its costs rise. In the December quarter, its cost per tonne rose by 13.9% over a year ago and by 4.7% sequentially. Refined zinc output declined by 2.4% over a year ago due to lower ore grades and lower open cast mine output. This was expected and output rose by 4.2% sequentially. Metal output is expected to increase in the March quarter, over the preceding quarter.
Thus, sales rose by 11.5% sequentially but costs increased by 17.2%, with royalty and other expenses being the main heads that rose substantially. That led to the company’s Ebitda (earnings before interest, tax, depreciation and amortization) increasing by 7.7% sequentially and the Ebitda margin narrowing by 2.2 percentage points. This happened despite a 9% sequential increase in LME (London Metal Exchange) zinc prices in dollar terms and 6.8% for lead, indicating that costs rose so much that it negated better realizations.
In the fourth quarter, refined zinc and lead output are projected to be nearly the same as the third quarter. That means realizations and costs will determine which way the profitability scale will tilt. While realizations are expected to hold steady, the expectation is that costs will trend lower due to higher coal linkage availability. If this happens, it may bring some solace to investors.
HZL continues to invest in its expansion projects with capacity expected to increase annually in the next two years. If zinc prices hold up, then it should be in a good position. The current investor concern is that at a time of firm zinc prices, the company’s profitability is slipping. That is understandable considering that its shares had risen by a fifth in 2017 and they trade at 11 times its consensus FY19 earnings per share estimate, as compiled by Reuters. For investors to regain confidence, they would want to see zinc prices rise even further or for HZL’s costs to moderate.
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