Hindustan Zinc's Q2FY19 results (Underperformer) - Lower price hurt profits

Q2FY19 result highlights- Rs20 interim DPS, a positive surprise

• Hindustan Zinc (HZ) reported higher-than-expected operating results due to lower-than-expected operating cost. It reported EBITDA of Rs23.3bn, down 14% qoq and blended EBITDA/t of US$1,595, down 17% qoq due to lower zinc prices (down 13% qoq). The mismatch in zinc mined metal availability caused by delay in ramp up of production from mines led refined zinc volume to fall by 5% qoq to 162kt. The higher coal cost led refined zinc production cost ex-royalty to rise by 4% qoq to Rs 72,449/t.
• Silver EBIT, at Rs5.1bn (27% of total EBIT), was up 7% qoq due to higher volume (up 14% qoq to 161t), partially offset by 4% qoq lower realisation.
• HZ reported net cash of ~Rs233bn (Rs55/share) at Q2FY19-end, up ~9% qoq.

Key Positives: Announced Rs20 interim DPS (record date: 31 Oct 2018)

Key Negatives: Low zinc volume; CoP to remain elevated in Rs terms in H2FY19 (Rs71,178/t in 1HFY19; At exchange rate of INR/USD of Rs73, H2FY19 guidance is Rs69,350/t-Rs71,175/t)

Change in estimates: Reduce our FY19 EBITDA by 6.4% and increase FY20 by 0.9% to factor in lower zinc prices & volume, partially offset by rupee depreciation

Valuation & view- Reiterate Underperformer with revised TP of Rs243

H2FY19 EBITDA is expected to be up ~30% from 1HFY19 due to higher volume (up 23% in H2 v/s H1FY19) offsetting lower realisation. However, this increase has already been factored in. We expect zinc prices to hover around current levels of ~US$2,660/t despite low levels of inventory as global zinc market deficit is expected to reduce gradually in CY19. The International Lead and Zinc Study group (ILZSG) forecasts global zinc deficit to reduce to ~100kt in CY19 v/s ~350kt during CY18 with 3% yoy increase in supply in CY19. We factor in average zinc price of US$2,650/t for 2HFY19E and for FY20E. To factor in Ytd zinc prices, we reduce our average LME zinc price to US$2,731/t (earlier US$2,831/t) in FY19E and US$2,650/t (earlier US$2,750/t) in FY20E which has been offset by rupee depreciation (revised our estimates from INR/USD of 67.5 to 70.0 in FY19E and 68.0 to 72.0 in FY20E).  We value HZ’s zinc business at 5.5x FY20E EV/EBITDA (global peers trading at 4.7x CY19E EV/EBITDA) and silver at 8.5x FY20E EV/EBITDA and arrive at a TP of Rs243 (Rs256 earlier). The reduction in TP is essentially due to Rs20 interim DPS v/s FY19 DPS expectation of Rs9. Reiterate Underperformer.