Zinc producer Hindustan Zinc Ltd has commenced production at a second zinc smelter in Rajasthan at a time when zinc prices have softened on worries of a global slowdown and because of a supply glut from China.
The new smelter will increase the company’s production capacity by 34% to 670,000 tonnes per year. Reduction of bottlenecks at its existing smelter plant is expected to increase capacity by another 88,000 tonnes next fiscal. By 2010, the company plans to have a production capacity of 1 million tonnes—about 50% higher than current levels. Considering that zinc prices have halved from last year’s high of about $4,500 (Rs1.77 lakh) per tonne, does the large increase in capacity make sense?
The sharp drop in zinc prices notwithstanding, the company still reported an operating margin of 71% in the September quarter. True, absolute operating profit fell by 23.5% on a year-on-year basis last quarter, because of a drop in product prices, but even then profit margins continue to be extremely high. Net profit margin (after adjusting for a one-time tax write-back) was also high at about 54% of net sales. The company operates low-cost zinc mines, and its access to captive zinc concentrate helps it achieve abnormally high profit margins. Even if zinc prices remain at current levels, earnings would grow in line with the addition in production capacity.
In the first 10 months of the current calendar year, exports of refined zinc from China increased by nearly 30%. This has led to increase in zinc stocks globally, and exacerbated the fall in zinc prices. But according to reports, the Chinese government is considering the replacement of an export rebate with an export tax, which should slow down exports from the country. Being the world’s largest zinc producer, accounting for about 30% of world production, any decrease in Chinese exports would have a positive bearing on global prices. At the same time, if the global economy slows down, demand would fall and pull down prices.
From an investor’s perspective, Hindustan Zinc shares have underperformed the Nifty by 33% this year and now trades at only about eight times trailing earnings. Reports that the Sterlite group plans to buy out the remainder of the government’s holding in the company provide a floor for the share price.
This is because the buy out would increase Sterlite’s stake to more than 90%, necessitating an offer to buyback minority shareholders.
Cash rich IVR Prime
Officials from IVR Prime Urban Developers Ltd, a subsidiary of IVRCL Infrastructures & Projects Ltd (IVRCL), announced on Friday that the company had received investment commitments of Rs250 crore from realty funds for its real estate projects. A note by Macquarie Research states that the IVRCL stock has been dragged down by the underperformance of IVR Prime, which, at Rs479, is still well below its offer price of Rs550, although it has recovered from its lows.
There can hardly be another explanation. The markets have been strangely lukewarm to the spate of new orders announced by IVRCL in the past few days and to its entry into oil exploration. The price has drifted down from a high of Rs535 touched on 9 November to its current price of Rs520. And this has happened despite total new orders worth Rs1,450 crore in the last couple of months. Most of the new orders are in its core area of water and irrigation projects. IVRCL’s subsidiary, Hindustan Dorr Oliver Ltd too has got several new orders recently.
Perhaps the sticking point has been its acquisition of Hyderabad-based Alkor Petro Ltd, an oil and gas exploration company with stakes in exploration blocks in Yemen and Egypt. While IVRCL will have to pay a sign-on bonus of Rs9 crore to the Yemen government and spend another $50 million over the next few years for exploring these blocks, the pay-off could be very large, even after sharing production with the country’s government. The problem, say analysts, is that it is premature to value the reserves since drilling is yet to commence.
Nevertheless, even without factoring in the oil exploration blocks, analysts point to the big push being given to infrastructure by the government, of which the company will be a beneficiary. The company’s second quarter results have been excellent, with revenues increasing by 89% and earnings before interest, taxes, depreciation and amortization (Ebitda) growing 79%. More importantly, revenue visibility is very high, with an order backlog of almost three times fiscal 2008 estimated sales. With earnings per share estimated between Rs12.7 for fiscal 2008 (according to Religare Securities Ltd) or Rs12.9 (according to Citigroup Inc. estimates), the P-E multiple at the current price is around 40 times. That looks high, but then analysts put earnings per share growth in fiscal 2009 at anything between 43% and 55%, easily justifying a higher price for the stock.
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