Vedanta group has clearly given up hope that the sale of the government’s stake in Hindustan Zinc Ltd (HZL) will happen in the foreseeable future. Why else would it decide on a hefty dividend that entails a huge tax outgo and enriches the government more than anyone else? Vedanta has a 64.9% stake in HZL, but its share in the magnanimous Rs13,985 crore payout by the latter will only be 53.9%.
The government, on the other hand, has a 29.5% stake in HZL, but gets 41.5% share of the spoils. This is thanks to the dividend distribution tax of over 20% that firms have to bear while paying dividends.
A number of companies such as Wipro Ltd and Bharti Airtel Ltd have used tender buybacks as a means to return cash to shareholders, given the large amount of tax savings. Vedanta, unfortunately, doesn’t have that luxury.
Because of a Supreme Court order that has stayed the sale of the government’s residual stake in HZL, it may not be able to participate in a tender buyback offer. And if the company were to go ahead with a buyback without the government participating, that would result in a drop in the government’s shareholding, which may again flout the apex court’s directives.
As such, dividends seem to be the only option left to take cash out of HZL. From Vedanta’s point of view, the ideal outcome would be to buy the government’s stake and then use its control over the company to directly pursue inorganic opportunities such as its interest in Anglo American Plc. Now, apart from gifting the government a disproportionate share of HZL’s cash, it also has to share the company’s cash with its minority shareholders, as well as those of Vedanta Ltd and Vedanta Plc (see chart).
Analysts at Credit Suisse Securities (India) Pvt. Ltd say Vedanta could use the funds to service some of its debt and to fund its stake purchase in Anglo American. “Depending on the extent of upstreaming at Vedanta Ltd and Vedanta Plc, the ultimate promoter entity (Volcan Investments Ltd) could receive $220-$500mn of dividend which could come in handy in pursuing its Anglo American ambitions,” wrote the analysts in a note to clients. Upstreaming refers to dividend payments by Vedanta Ltd and Vedanta Plc from their respective dividend income. In other words, Volcan may eventually get only 20-23% of the total payout by HZL.
From HZL’s point of view, while the outflow looks huge, it hardly poses much of a problem for it. As of 31 December, the company’s net cash and cash equivalents were Rs25,319 crore. Post the dividend payouts, its cash balance is expected to drop to Rs15,000 crore, point out analysts from Edelweiss Securities Ltd. But that shouldn’t worry investors. Edelweiss pegs free cash flow generation at Rs10,000 crore each for fiscal years 2018 and 2019 on the back of robust zinc price outlook and capacity ramp-up.
HZL shares have risen about 88% in the past year, thanks to the rally in zinc prices. But as Credit Suisse’s analysts point out, valuations are rich. “Even with our bullish Ebitda estimates, the stock is trading at a high 8x EV-Ebitda multiple: valuations have rarely been this rich,” they said in another note on 6 February. EV is short for enterprise value, and Ebitda is earnings before interest, tax, depreciation and amortization. HZL’s shares have been more or less flat since, while zinc prices have averaged at around $2,800/tonne, about $100/tonne lower than the levels the broker has used for its earnings estimates.