HINDUSTAN ZINC New frontiers to keep up the zing

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1 RESULT UPDATE HINDUSTAN ZINC New frontiers to keep up the zing India Equity Research Metals and Mining We reiterate BUY on Hindustan Zinc (HZL) with TP of INR395, implying 20% upside from current levels as: 1) growth momentum is expected to sustain with 1.35mtpa production capacity by FY23E; 2) Q4FY18 Cost of Production (CoP) fell 10% QoQ at USD925; and 3) sustained tightness is expected in zinc (Zn) market. Q4FY18 performance was slightly ahead of consensus owing to lower cost and higher silver volume. On volume growth and cost efficiencies we estimate EPS CAGR of 15% through to FY20. Our TP implies exit multiple of 12.7x, broadly in line with the stock s recent trading range. In-line quarter HZL s Q4FY18 EBITDA of INR36.2bn was ahead of estimates due to: 1) record silver volume of 170 tonnes owing to ramp up of Sindesar Khurd (SK) mine; and 2) CoP at USD925/t (down 9%QoQ) owing to higher proportion of linkage coal (March exit rate at 30%). Going ahead, we expect EPS CAGR of 15% through to FY20E on: 1) capacity ramp up to 1.2mtpa which is largely on track; 2) cost efficiencies moving up to USD 30-35/t from reduced haulage cost and higher proportion of linkage coal; and 3) silver volume ramping up from 558tonnes in FY18 to ~750 tonnes by FY20E (refer Hindustan Zinc - Making hay while Zinc shines!; visit note; Buy). Upbeat on next phase of expansion program We are upbeat on HZL s next phase of expansion program that will enable it to increase mined metal (MM) production capacity by 1.4x FY18 to 1.35mtpa by FY23E and ultimately to 1.5mtpa. We believe this will enable the company to enhance its market share in the global markets, while maintaining cost leadership. We expect HZL to benefit from tight zinc market as: 1) new capacities coming onboard are still lower than incremental demand; and 2) global inventories remain at historically lowest level of six days of consumption. Outlook and valuations: Sustained growth seen; maintain BUY We see HZL benefitting from volume growth of 1.2mtpa by FY20E and favourable Zn macro environment. As a result, we expect EPS CAGR 15% through to FY20. At CMP, the stock is trading at 11.1x FY20E EPS. We maintain BUY/SO with TP of INR395, implying exit multiple of 12.7x, in line with its recent trading range. Financials Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. (INR mn) Year to March Q4FY18 Q4FY17 % Chg Q3FY18 % Chg FY18 FY19E FY20E Net revenues 62,770 67,562 (7.1) 59, , , ,807 EBITDA 36,200 37,480 (3.4) 32, , , ,611 Adjusted Profit 25,410 30,570 (16.9) 22, , , ,908 Adjusted Diluted EPS (16.9) Diluted P/E (x) EV/EBITDA (x) ROAE (%) EDELWEISS 4D RATINGS Absolute Rating Rating Relative to Sector Risk Rating Relative to Sector Sector Relative to Market BUY Edelweiss Securities Limited Outperform Low Overweight MARKET DATA (R: HZNC.BO, B: HZ IN) CMP : INR 327 Target Price : INR week range (INR) : 340 / 227 Share in issue (mn) : 4,225.3 M cap (INR bn/usd mn) : 1,381 / 20,740 Avg. Daily Vol.BSE/NSE( 000) : 2,221.9 SHARE HOLDING PATTERN (%) Current Q3FY18 Q2FY18 Promoters * MF's, FI's & BK s FII's Others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Stock Nifty : NIL EW Metals and Mining Index 1 month months 5.4 (2.6) (7.5) 12 months Amit A Dixit amita.dixit@edelweissfin.com April 30, 2018

2 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (%) ((INR mn) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (kt) (kt) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 (Tonnes) (USD/t) ('000 tonnes) Metals and Mining Chart 1: Outperformance led by record level of silver volume Chart 2: and reduced COP/t 1, (20) Refined silver Chart 3: Steady ramp in Zn volume Mined metal production Zinc- COP without Royalty- USD Chart 4: with spurt in lead volume Total Zinc Total Lead Chart 5: leads to yet another quarter of EBITDA growth ,500 34,200 26, ,600 12,300 5,000 EBITDA EBITDA margin Source: 2 Edelweiss Securities Limited

3 Hindustan Zinc Table 1: Q4FY18 EBITDA led by SK mine ramp up Year to March Q4FY18 Q4FY17 Y-o-Y (%) Q3FY18 Q-o-Q (%) Production volume Mined metal content (Kt) (18.3) Refined zinc integrated (Kt) (4.1) Refined lead - integrated (Kt) Salable silver production (tonnes) Wind power (MU) (22.7) Sales volume Refined zinc (Kt) (3.2) Refined lead (Kt) Silver (tonnes) Net sales value Zinc (INR mn) 45,640 51,380 (11.2) 44, Lead (INR mn) 8,670 8, , Silver (INR mn) 6,370 5, , Other (INR mn) 1,060 1,190 (10.9) 1,060 - Total (INR mn) 61,740 66,710 (7.5) 58, EBITDA (INR mn) 36,600 37,450 (2.3) 32, EBITDA margin (%) Net realisations Zinc (USD/t) 3,357 3,510 (4.4) 3,448 (2.6) Lead (USD/t) 2,678 2,684 (0.2) 2,724 (1.7) Silver (INR/kg) 38,144 45,135 (15.5) 39,318 (3.0) Blended EBITDA/t (INR/t) 140, ,789 (0.8) 132, Blended EBITDA/t (USD/t) 2,173 2, , Q4FY18: Key conference call highlights Macro outlook: Market tightness to keep Zn prices at high levels Source: Management reiterated bullish outlook for Zn due to low global inventory (six days of consumption) and continued supply constraints. In CY19, demand for finished Zn is expected to grow at 2.5% to 14mt as compared to supply growth of 5% to 13.6mt. Normal Zn inventory at stock exchanges has historically been 20 days of consumption. Zn market tightness is likely to continue as against 1.5mt of incremental demand; supply is expected to grow only by 1mt. Zn market is highly sensitive to the timing of new supply coming on board. However, management expects market tightness to continue as incremental supply is lower than demand. Operational highlights In FY18, underground production of ore and MIC went up 26% YoY and 52% YoY, respectively. Metal in Concentrate (MiC) production at 714kt was the highest. The last leg of open pit mining was completed in Q4FY18. Henceforth, the entire production would be underground. Average Zn-lead grade in Q4FY18 was at 8.74% compared to 11% in Q4FY17. Zn grade has improved sequentially with underground transition complete. 3 Edelweiss Securities Limited

4 Metals and Mining HZL is making scheduled transition to underground mining with total production from UG mines increasing by 54% YoY to 714kt. In FY19, management expects MiC production to be slightly higher as compared to FY18 with estimated split of 45:55 between the two halves of the year. The Zn metal CoP/t before royalty was INR (USD925) in Q4FY18, up 12% YoY (down 10% QoQ), primarily due to higher cost of carbon products (up 50% YoY) and oil derivatives and lower grades. However, management is confident that overall cost in FY19 will be in the USD /t range as proportion of linkage coal increases progressively and grades improve. HZL is expected to source 40% of coal through linkages. The company will be participating in upcoming coal auctions to further increase the domestic coal mix. Imported coal cost for Q4FY18 was USD92/t. Management expects this cost to come down to USD85/t in FY19. HZL has residual hedges of 70kt for Zn at USD3,076/t and 15kt for lead at USD2,374/t. This will be exhausted in Q1FY19. Management has not taken any further forward contracts going ahead. Reserves and Resources (R&R) at the end of FY18 stood at estimated 411mt. HZL added 19.5mt in FY18 as against depletion of 12.5mt. 1.2mtpa in sight, planning for next frontier of 1.5mtpa HZL is evaluating plans to increase its mined metal capacity from 1.2mtpa to 1.5mtpa. Phase 1 of the project has been approved which is likely to increase MIC capacity from 1.2 to 1.35mtpa in three years at an investment of INR 45bn. HZL will be putting up a new smelter of 240ktpa (likely at Dariba). Capacity increment at Rampur Agucha, Sindersar Khurd and Raajpur Daariba mines is expected at 0.5mtpa each. Outlook and guidance: Reiterated production guidance of 1.2mt by FY20 FY19E MIC is expected to be slightly higher as compared to FY18 Silver production is expected to be tonnes in FY19 COP/t before royalty is expected to be USD Tax rate is expected to slightly higher as compared to FY18 Project capex in FY19 is expected to be USD 400mn Quarterly depreciation expense is expected to be INR3.5-4bn Q3FY18: Key conference call highlights Macro outlook: Management maintains bullish outlook on zinc Management reiterated bullish outlook for zinc due to low global inventory (7 days of consumption) and continued supply constraints. In CY18, demand for finished zinc is expected at 14.8mt against mined supply of 13.8mt. Indian consumption is expected to grow 4% YoY in FY19E. Global outlook also looks promising with positive macro indicators in Europe and stable (but slow) demand in China. 4 Edelweiss Securities Limited

5 Hindustan Zinc Operational highlights Average zinc grade in Q3FY18 was lower at 6.15% compared to 8.6% in Q3FY17 and 8.13% in Q2FY18. HZL is making scheduled transition to underground mining with 100% production expected to come through this route in FY19. This is expected to increase the grade as well as reduce logistics cost up to USD25/t. The zinc metal CoP/t before royalty was INR66,118 (USD1,022) in Q3FY18, up 14% YoY, primarily due to higher cost of carbon products (up 50% YoY) and oil derivatives and lower grades. However, management is confident that overall cost in FY18 will be in the USD /t range as proportion of linkage coal increases progressively and grades improve. HZL is expected to ramp up sourcing from linkages to 40% progressively. Additionally, the company will participate in future auctions. Management stated that coal supply through linkages has only commenced in Q4FY18 as Coal India was diverting production to power plants in Q3FY18. HZL hedged 220kt of zinc and 30kt of lead at a price of USD3,084/t and USD2,418/t, respectively. Of this, while 165kt is for Q4FY18, balance is for Q1FY19. Currently, there are no further hedges. Depreciation during the quarter has gone with ramp up of mined metal production and capitalisation of new mills. Management expects the quarterly run rate to be at INR45-50bn. Treasury income is expected to be in the INR3.5-4bn range. In the current quarter, it was affected to the extent of INR0.75bn owing to reduced corpus and INR1.15bn owing to reduction in yield rate by 70bps. Current cash balance is at INR192bn. HZL paid off the balance tranche of INR6bn of short term debt and incurred INR7bn in capex in Q3FY18. Outlook and guidance: Reiterated production guidance of 1.2mt by FY20 HZL reiterated that zinc-lead metal production will be 950kt in FY18, while silver production will be over 500t. In FY20, mined metal production is expected to be 1.2mt, while silver production is estimated at ~750tonne. Management expects COP to dip in FY19 via combination of increased sourcing through linkages, improvement in grades and production efficiency. Annual tax rate is expected to be slightly higher than MAT at almost 23%. 5 Edelweiss Securities Limited

6 Metals and Mining Financial snapshot (INR mn) Year to March Q4FY18 Q4FY17 % change Q3FY18 % change FY18 FY19E FY20E Net revenues 62,770 67,562 (7.1) 59, , , ,807 Dec/(inc) in stock 180 (2,004) (109.0) 2,310 (92.2) Raw material costs ,156 2,264 2,377 Stores & spares ,693 2,257 3,720 Power and fuel 4,420 3, , ,387 16,969 19,597 SG&A - 1,565 (100.0) Employee expenses 1,820 1,895 (4.0) 1,950 (6.7) 7,760 7,776 7,931 Other Expenses 11,860 16,227 (26.9) 11, ,653 50,296 55,392 Mining royalty 8,290 8,463 (2.0) 7, ,470 29,308 32,178 Total expenditure 26,570 30,081 (11.7) 26,780 (0.8) 98, , ,196 EBITDA 36,200 37,480 (3.4) 32, , , ,611 Depreciation 4,590 5,321 (13.7) 4,810 (4.6) 14,830 19,611 20,569 EBIT 31,610 32,159 (1.7) 27, , , ,042 Other income 4,860 4, , ,510 16,481 21,052 Interest , Add: Exceptional items (510) Profit before tax 35,510 36,829 (3.6) 30, , , ,094 Provision for taxes 10,460 6, , ,210 40,130 48,186 Reported net profit 25,050 30,570 (18.1) 22, , , ,908 Adjusted Profit 25,410 30,570 (16.9) 22, , , ,908 Diluted shares (mn) 4,225 4,225 4,225 4,225 4,225 4,225 Adjusted Diluted EPS (16.9) Diluted P/E (x) EV/EBITDA (x) ROAE (%) Raw material 0.3 (3.0) Employee cost Stores & spares Power & fuel Mining royalty SG&A EBITDA Reported net profit Tax rate Change in Estimates FY19E FY20E New Old % change New Old % change Comments Net Revenue 266, ,556 (0.8) 292, ,277 (2.2) Estimates changed in line with EBITDA 157, , , , EBITDA Margin Adjusted After Tax Profit 114, , , ,183 (1.0) Net Profit Margin Capex 26,400 22, ,400 23, management s guidance. 6 Edelweiss Securities Limited

7 Company Description Hindustan Zinc HZL is a part of the Vedanta Group and is the only integrated zinc manufacturer in India, with zinc smelting capacity of 823 ktpa and lead smelting capacity of 185 ktpa. The company is the second-largest integrated zinc and lead producer in the world. It caters to ~80% of zinc demand in India. The company s fully-integrated zinc operations include three lead-zinc mines, two zinc smelters, a lead smelter, and one lead-zinc smelter in Rajasthan. HZL s mines supply most of its concentrate requirements. Investment Theme Continued supply constraints following mine closures provide a stable growth outlook for Zinc going forward. Further, volume ramp in the forecast period will result in benefits of operating leverage. We like HZL for its ability to deliver ~50% EBITDA margins and maintain good dividend yield. It is among the lowest cost in the world and has a strong Balance Sheet with no debt. Key Risks HZL s share price is sensitive to LME zinc prices. Lower-than-estimated LME prices in the event of a demand slowdown or oversupply will adversely impact the company s earnings. Lower than expected volume growth INR appreciation and/or lower metal premiums 7 Edelweiss Securities Limited

8 Metals and Mining Financial Statements Key Assumptions Macro GDP(Y-o-Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Sector Zinc LME (USD/t) 2, , , ,881.9 Lead LME (USD/t) 2, , , ,259.4 Copper Tc/Rc (c/lb) Company Zinc production (t) 671, , , ,760 Lead production (t) 144, , , ,500 Silver production (kg) 488, , , ,000 Zinc premium (USD/t) Lead premium (USD/t) Mining & mfg cost(inr/t) 70,363 66,621 71,411 72,060 Zinc royalty (%) Lead royalty (%) Employee exp. growth (%) SG&A expenses growth (%) Capex (INR mn) 23,625 24,062 26,400 26,400 Net borrowings (INR mn) (320,703) (221,860) (289,689) (363,740) Cash conversion cycle Depreciation rate (%) Dividend payout (%) Debtor days Inventory days Payable days Tax rate (%) Income statement (INR mn) Net revenue 187, , , ,807 Materials costs 57,436 63,890 71,786 81,087 Accretion to stock (3,141) Mining Royalty 22,692 26,470 29,308 32,178 Employee costs 7,220 7,760 7,776 7,931 Total SG&A expenses 6, Total operating expenses 90,596 98, , ,196 EBITDA 97, , , ,611 Depreciation 18,112 14,830 19,611 20,569 EBIT 79, , , ,042 Add: Other income 24, , , , Less: Interest Expense 2,017 2, Add: Exceptional items - 2, Profit Before Tax 101, , , ,094 Less: Provision for Tax 18,837 32,210 40,130 48,186 Reported Profit 83,156 97, , ,908 Exceptional Items - 1, Adjusted Profit 83,156 95, , ,908 Shares o /s (mn) 4,225 4,225 4,225 4,225 Adjusted Basic EPS Diluted shares o/s (mn) 4,225 4,225 4,225 4,225 Adjusted Diluted EPS Adjusted Cash EPS Dividend per share (DPS) Dividend Payout Ratio(%) Common size metrics Operating expenses Depreciation Interest Expense EBITDA margins Net Profit margins Growth ratios (%) Revenues EBITDA PBT Adjusted Profit EPS Edelweiss Securities Limited

9 Hindustan Zinc Balance sheet (INR mn) As on 31st March FY17 FY18 FY19E FY20E Share capital 8,451 8,451 8,451 8,451 Reserves & Surplus 299, , , ,269 Shareholders' funds 308, , , ,720 Total Borrowings 80, Long Term Liabilities 1,697 59,670 59,670 59,670 Def. Tax Liability (net) 6,677 (22,080) (16,340) (10,600) Sources of funds 396, , , ,790 Gross Block 174, , , ,112 Net Block 98, , , ,430 Capital work in progress 30,713 32,200 32,200 32,200 Intangible Assets 1,275 1,210 1,210 1,210 Total Fixed Assets 130, , , ,840 Non current investments 40,822 20,590 20,590 20,590 Cash and Equivalents 321, , , ,740 Inventories 19,358 13,790 19,464 22,745 Sundry Debtors 1,360 1,840 1,691 2,191 Loans & Advances Other Current Assets 4,128 3,930 3,930 3,930 Current Assets (ex cash) 24,864 19,570 25,096 28,876 Trade payable 12,051 9,470 10,775 9,397 Other Current Liab 109, Total Current Liab 121,530 10,330 11,635 10,257 Net Curr Assets-ex cash (96,665) 9,240 13,461 18,619 Uses of funds 396, , , ,790 BVPS (INR) Free cash flow (INR mn) Reported Profit 83,156 97, , ,908 Add: Depreciation 18,112 14,830 19,611 20,569 Interest (Net of Tax) 1,644 2, Others (27,485) (36,184) (10,741) (15,312) Less: Changes in WC (86,838) 47,933 4,221 5,158 Operating cash flow 162,266 29, , ,007 Less: Capex 23,625 24,062 26,400 26,400 Free Cash Flow 138,641 5,907 92,466 97,607 Cash flow metrics Operating cash flow 162,266 29, , ,007 Investing cash flow 115,110 29,055 (9,919) (5,348) Financing cash flow (193,889) (123,398) (41,118) (44,607) Net cash Flow 83,487 (64,374) 67,829 74,052 Capex (23,625) (24,062) (26,400) (26,400) Dividend paid (270,758) (40,563) (41,118) (44,607) Profitability and efficiency ratios ROAE (%) ROACE (%) Debtors Days Payable Days Cash Conversion Cycle Current Ratio Gross Debt/EBITDA Gross Debt/Equity Adjusted Debt/Equity Net Debt/Equity (78.4) (61.7) (67.0) (71.1) Interest Coverage Ratio 3, , Operating ratios Total Asset Turnover Fixed Asset Turnover Equity Turnover Valuation parameters Adj. Diluted EPS (INR) Y-o-Y growth (%) Adjusted Cash EPS (INR) EV / Sales (x) EV / EBITDA (x) Peer comparison valuation Market cap Diluted P/E (X) EV / EBITDA (X) ROAE (%) Name (USD mn) FY19E FY20E FY19E FY20E FY19E FY20E Hindustan Zinc 20, Korea Zinc Co Ltd 7, United Co RUSAL PLC 4, Median AVERAGE Source: Edelweiss research 9 Edelweiss Securities Limited

10 Metals and Mining Additional Data Directors Data Agnivesh Agarwal Chairman Navin Agarwal Director A R Narayanaswamy Director Reena Sinha Puri Director Sunil Duggal CEO & Whole-time Director Farida M. Naik Director Arun L. Todarwal Director Sudhir Kumar Director Auditors - Deloitte Haskins & Sells *as per last annual report Holding Top10 Perc. Holding Perc. Holding Vedanta limited Government of india Goldman sachs group 0.38 Janus henderson grou 0.29 Vanguard group 0.19 Hdfc life insurance 0.17 L&t mutual fund 0.17 Uti asset management 0.16 Aditya birla sun lif 0.16 Sbi funds management 0.1 *in last one year Bulk Deals Data Acquired / Seller B/S Qty Traded Price No Data Available *in last one year Insider Trades Reporting Data Acquired / Seller B/S Qty Traded No Data Available *in last one year 10 Edelweiss Securities Limited

11 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Coal India HOLD SP M Hindalco Industries BUY SO M Hindustan Zinc BUY SO L Jindal Steel & Power BUY SO M JSW Steel BUY SO M NMDC BUY SO M Steel Authority of India REDUCE SU M Tata Steel BUY SO M Vedanta BUY SO M ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 11 Edelweiss Securities Limited

12 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 (INR) Metals and Mining Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91-22) , Aditya Narain Head of Research Coverage group(s) of stocks by primary analyst(s): Metals and Mining Coal India, Hindalco Industries, Hindustan Zinc, Jindal Steel & Power, JSW Steel, NMDC, Steel Authority of India, Tata Steel, Vedanta Recent Research Date Company Title Price (INR) Recos 25-Apr-18 Jindal Stainless Turning around..; Result Update 105 Not Rated 25-Apr-18 Globl Pulse: Norsk Hydro Watch out for alumina...; Result Excerpts Not Rated 24-Apr-18 Global Pulse : Lower shipments and Fortescue realisation dampen Metals Group performance; Result Excerpts Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation Buy Hold Reduce Total Rating Distribution* * 1stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Rating Buy Hold Reduce Expected to appreciate more than 15% over a 12-month period appreciate up to 15% over a 12-month period depreciate more than 5% over a 12-month period One year price chart Hindustan Zinc 12 Edelweiss Securities Limited

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