Hindustan Zinc's Q2FY20 results (Neutral) - Lower zinc prices and silver volumes hit EBITDA

Q2FY20 result highlights- in line operating profits

• HZ reported EBITDA of Rs21.2bn, down 14.5% qoq due to lower zinc prices and lower silver volumes. Mined metal production at 219,000t, though up 3% qoq, but was adversely affected due to technical issues at SK and Rampur Agucha mine leading to lower average ore grade (7.18% in Q2 Vs 7.31% in Q1). Lower mined metal volume along with lower ore grade and annual maintenance shutdown of smelters at Dariba in July, led to lower integrated metal production (210,000t, down 4% qoq) and lower silver production.
• Zinc realisations (derived) were lower by 14% qoq to US$2,580/t while volumes were flat qoq at 167,900t. Benefits of higher lead prices (up 5% qoq) were offset by lower lead volumes (down 7.6% qoq to 43,900t). Despite absence of power purchase in Q2, lower imported coal prices and higher linkage coal availability, refined zinc CoP ex-royalty was down only 2% qoq to US$1,048/t (down 1% in INR). This was due to lower ore grades, increase in electricity duty, higher mine development expenses and lower acid credits.
• Silver EBIT, at Rs4.97bn (~32% of total EBIT), was driven by higher silver prices (Rs42,836/t, up 15% qoq) offset by lower silver volumes (134.7t, down 13% qoq).
• HZ reported net cash of ~Rs196bn (Rs46/sh) at Q2FY20-end, up ~8% qoq.
• HZ has lowered its FY20 mined and refined metal production guidance by 50,000t to 950,000t each and silver production guidance by 150t to 650t.

Key Positives: Lower CoP

Key Negatives: Lower silver volumes and zinc prices, No interim dividend announced, FY20 production guidance cut

Impact on financials: Cut FY20E/FY21E EBITDA by 6%/2% to factor in lower zinc and silver volumes.

Valuation & view- Maintain Neutral with revised TP of Rs212

Zinc prices have rebounded by 10% in last one month to US$2,590/t on lower mine production across globe and lower inventories at global warehouses. With Glencore cutting output by 85,000t in CY19e and HZ lowering production guidance in FY20, we expect zinc market to remain tight in FY20 and as a result, expect prices to remain high (CMP- US$2,590/t) in H2FY20 before tapering off to US$2,400/t in FY21E. We 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 Rs212/sh (earlier Rs216/sh). We continue to expect a dividend of Rs14/sh in FY20E. We maintain Neutral on the stock, however, special dividend declaration and divestment of GoI's stake in HZ pose a upside risk to our target price.