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Results in line, valuations expensive; maintain Neutral

Likely acquisition of international zinc assets could impact earnings

* Hindustan Zinc (HZL) reported yet another quarter of strong EBITDA at INR43.7b, up 31% QoQ, driven by 23% higher metal sales and 12% rise in Zinc LME price. Silver sales also increased 14% QoQ to 173 tonnes.

* We believe the stock already priced in 1.2mt of metal sales for FY23, but it is not factoring in the probability of acquisition of the international Zinc assets of Vedanta at the peak of the zinc cycle. This could impact the quality of the assets, earnings and balance sheet of the company. We maintain our Neutral rating with a TP of INR311 valuing HZL at 7x FY23 EV/EBITDA.

EBITDA rises 31% QoQ, albeit 5% below estimates

* EBITDA grew 31% QoQ and 34% YoY, driven by higher LME and zinc sales, though lead sales were flat QoQ at 47kt. Though zinc sales appeared to have grown QoQ, the sales have actually normalized after a roaster was shut in 2Q, leading to lower volumes. We are not expecting any material growth in 4Q.

* PAT for the quarter stood at INR27b up 23% YoY and 34% QoQ, but was 8% lower than our estimate of INR29.3b.

* Mined metal production was at 252kt, up 3% YoY and almost flat QoQ (up 1%) in 3QFY22. We project a marginal 3% growth in 4QFY22 production level. Silver production rose 14% QoQ due to depletion of WIP, which was in line with our estimates.

* Zinc sales rose 29% sequentially to 212kt, in line with our estimates too. Lead sales were flat at 47kt. Silver sales grew 14% QoQ to 173kt in 3QFY22.

* HZL’s 9MFY22 topline grew 32% YoY to INR206b driven by 34% rise in LME Zinc price and 4% rise in refined metal sales, offset by 9% lower Silver sales.

* The company’s EBITDA climbed 44% YoY to INR113b while PAT shot up 24% YoY to INR68b in 9MFY22. However, the PAT growth was significantly lower than EBITDA growth as Other Income declined 38% in 9MFY22, due to a contraction in yield on cash and investments.

Costs continue to escalate

* Reported CoP was up 5% QoQ at USD11,148/t due to higher coal costs, as highlighted by the management in the 2Q earnings call (2HFY22 cost will be higher by USD50/t). We expect coal costs to remain elevated as the company has already contracted for coal at a higher cost until Feb’22.

* Other income declined 10% QoQ to INR2.8b on lower cash due to dividend payout and continued capex. Cash balance stood at INR170b (INR40/sh) in 3QFY22 down from INR237b in 2Q

Target of 1.2mt delivery is running a year behind schedule

* The management hopes to deliver an exit rate of 1.2mt during 4QFY22. It came closest to delivering 1.2mt annualized during 4QFY21 but production declined in subsequent quarters.

* The company plans to start on its 1.35mt expansion target only after delivering 1.2mt on a sustainable basis. We believe FY23 production is likely to remain flat with a marginal growth expected. We factor in 1.19mt mined metal production in FY23E and 1.2mt in FY24E.

Valuation and view: Zinc prices to dip in FY23E; China’s revival a key risk

* The market is likely to remain in surplus in CY22 and any easing of power situation in Europe will augment the surplus as smelters would improve their operating rates. This should result in softening Zinc prices in FY23E; we build in Zinc prices at an average of USD2,750/t for FY23E.

* We maintain our Neutral rating with a TP of INR311 (based on 7x FY23E EV/EBITDA). The stock is trading at 7.4x FY22 EV/ EBITDA estimate. Strong recovery in China, which could keep LME prices at current level, is a key risk.

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