Hindustan Zinc's Q1FY20 result's (Upgrade to Neutral) - Lower volumes, higher cost hits EBITDA

Q1FY20 result highlights- in line operating profits

• HZ reported EBITDA of Rs24.8bn, down 11% qoq dragged by lower volumes and lower Lead prices. Refined zinc and lead volumes were down by 5.4% qoq to 167kt and 8.7% qoq to 47kt respectively. Derived Lead realisations were down 7% qoq to Rs144k/t mainly due to lower LME whereas zinc realisations was up 1% qoq to Rs209k/t. Refined zinc CoP ex-royalty was up 8% qoq to US$1,067/t (up 7% in INR) due to lower mined metal volumes, lower grade (7.3% v/s 7.55% in Q4FY19) and higher power cost which inturn was due to purchase of power (additional power of 75m units) from outside. Captive power generation was affected due to water scarcity which has been subsided now.
• Silver EBIT, at Rs5.0bn (~26% of total EBIT), was down 21.8% qoq due to lower volume (down 22% qoq to 155t).
• HZ reported net cash of ~Rs183bn (Rs43/share) at Q1FY20-end, up ~8% qoq.

Key Negatives: Lower mined metal volumes, higher CoP

Impact on financials: Cut FY20E EBITDA by 6% to factor in lower zinc volume, high cost and FY21E EBITDA by 2% to factor in higher cost; Change FY20E USD/INR exchange rate to Rs70 (earlier Rs72).

Valuation & view- Upgrade to Neutral with revised TP of Rs216

We expect HZ’s EBITDA to increase at 4% CAGR to Rs116bn over FY19-21E. An expected 11% CAGR in metal volumes to 1.12mt to be offset by lower zinc prices. Lower zinc inventories in LME and supply disruptions in Q1FY20 (Avg: US$2,759/t) kept zinc prices elevated, however, the prices have corrected since then (CMP:US$2,456/t). The International Lead and Zinc Study group (ILZSG) has forecast deficit in zinc market to reduce to 121kt in CY19E (vs 384kt in CY18) as supply is expected to grow by ~3.2% yoy against muted demand growth of 0.6% yoy. As a result, we expect LME zinc prices to hover around US$2,500/t and average US$2,580/t in FY20E and further taper off to US$2,400/t in FY21E. We roll over HZ’s valuation to FY21E and value HZ’s zinc business at 5.5x FY21E EV/EBITDA  and silver at 8.5x FY21E EV/EBITDA and arrive at a revised target price of Rs216/sh (earlier Rs212/sh). At CMP of Rs220, the stock is trading at 6.5x FY21E EV/EBITDA. Due to limited downside in stock price, we upgrade the stock rating from Underperformer to Neutral.