Hindustan Zinc's Q3FY18 results (Underperformer) - Hedging to restrict profitability in Q4FY18

Q3FY18 result highlights- Higher CoP offset pricing gain

• Hindustan Zinc (HZ) reported in-line operating results with EBITDA of Rs32.4bn, up 7% qoq and EBITDA/t of US$2,046 v/s US$2,018 in Q2FY18. The results could have been better with increase in zinc and lead prices (up 10% qoq) but was offset by higher production cost (up 4% qoq to US$1,022/t) and lower profits from silver. Higher production cost was due to lower grade of mined metal (8.01% v/s 8.13% in Q2FY18) and higher material cost.
• Other income, at Rs2.98bn, was down 39% qoq due to lower cash balance (hit of Rs750m qoq) and higher G-Sec rate due to which HZ recorded MTM loss (hit of Rs1.15bn qoq).  Depreciation, at Rs4.8bn, was 22% qoq higher due to capitalisation of a mill and higher mined metal production. As a result, PAT stood at Rs22.3bn, down 1% qoq.
• HZ has net cash of ~Rs192bn (Rs45/share) at Q3FY18-end.
• During Q3FY18, the management hedged a major part of Q4FY18 zinc volume for the first time. HZ hedged 220kt of zinc (165kt in Q4FY18 i.e. ~85% of Q4FY18E volume and 55kt in Q1FY19) at US$3,084/t (CMP is ~US$3,400/t) and 30kt of lead at US$2,418/t (CMP: US$2,560/t).

Key Positives: FY18 volume guidance maintained; positive commentary on zinc market; COP to be lower 10% qoq in Q4FY18E

Key Negatives: Increase FY18E CoP guidance to US$950-975/t (earlier guidance was US$900-950/t)

Impact on financials: Reduce FY18E profits by 8%, increase FY19E by 3%; introduce FY20E estimates

Valuation & view- Reiterate Underperformer with TP of Rs278

Glencore’s commentary to restart its closed zinc mines in phases will continue to keep global zinc market in deficit in CY18E. As a result, zinc prices are expected to remain firm in FY19E and then taper off in FY20E. We have factored in average LME zinc price of US$3,200/t (earlier US$2,900/t) in FY19E and US$2,900/t in FY20E. We believe the stock price factors in average zinc price of US$3,300/t in FY20E (at 7.0x FY20E EV/EBITDA) and as a result does not provide any upside. Global zinc producers are trading at an average of 5.6x 1-year fwd EV/EBITDA (HZ trading at 7.8x FY20E EV/EBITDA). The solace is that the stock is available at a dividend yield of 5% (expect DPS of Rs17 in FY18E). We reiterate Underperformer with a target price of Rs278, valuing HZ at 7.0x FY20E EV/EBITDA.