Hindustan Zinc - Galvanize Capital of Investors?

Stock Opportunities Not-so-Hidden Gems
1

I purchased Hind Zinc Mar Futures at 161 in March. Subsequently, Hindustan Zinc declared that there would be a board meeting on 30 Mar, to declare a dividend, with a record date of 7 April.

The April Futures were trading at a 2 Rs. discount, presumably because of the impending dividend. So I subsequently rolled over my March Futures to April Futures.

Yesterday, instead of the usual 2 Rs. or so dividend, Hindustan Zinc declared a whopping 24 Rs. dividend. I was upset when I heard this news last night, because in my opinion, what it meant was that the April Futures that I was holding would immediately start trading at a 24 Rs. discount to the spot price.

To my surprise, in the morning today, the April future opened at 191 Rs. Without much thought, I immediately squared off and booked profit.

When I reflected on this a little more, I thought this was a crazy situation. So I shorted a large quantity at 186.5. These futures are trading currently at 182.5.

According to me, the underlying price on 7th April should become 172 (the price yesterday)-24(the dividend)-4(the dividend distribution tax), so around 144 Rs… With some margin on safety, maybe it could be 150. However, at the current future price of 182.5, shorting futures, to my mind, represents a clear profit in 7 days, on a risk free basis.

So I am wondering what’s the catch?

Regards
Samir

2

Thanks for pointing this out @samir_brd

I am told that the new rules indicate if dividend >10% of market price, the strikes for F&O will also adjust downwards when the shares go ex dividend.

Therefore my understanding is that there is no free lunch here. Please correct me if I am wrong.

1 Like
3

Hi Samir,

I’ll not be able to comment on your futures position/strategy, but i certainly noticed a gap in the way you arrived at the underlying price. I have some experience in tracking the behavior of ex-dividend price pattern of stocks under some strategy (not associated with F&O). Here’s my few cents (literally)

  • Fundamentally the ex-dividend price should lie in the range of = Price on 31 Mar, 2016 ( the day information regarding the quantum of dividend being paid becomes a published information and duly acted upon in the market) less the dividend declared
  • In Practice two more factors adds to the above i.e. (a) Price before the ex-date day i.e. on 5 April (b) the general market mood on the ex-date itself (i.e. random noise)

If i extrapolate the above two, (and say if i have to take a bet on the underlying on the ex-date) - I would take the Price on 31 Mar ( or/and wait and refine on 5 April) less the dividend declared i.e. Rs. 24 less random noise of 2-3% on downside. Doing all this, i see nothing on risk free basis.Moreover its a big company, the adjustment should be smooth

There might be some money but definitely there are no free lunches.

It was a very subjective opinion, clinging to the conservative end. Counter-view is most welcome.

Do share the pay-offs of your strategy, in case you go ahead.

Best

4

Dear Rohan

Thanks for clearing my confusion.

You are right. This is what the NSE site says about this:

Dividends which are below 10% of the market value of the underlying stock, would be deemed to be ordinary dividends and no adjustment in the Strike Price would be made for ordinary dividends. For extra-ordinary dividends, above 10% of the market value of the underlying security, the Strike Price would be adjusted.
To decide whether the dividend is “extra-ordinary” (i.e. over 10% of the market price of the underlying stock.), the market price would mean the closing price of the scrip on the day previous to the date on which the announcement of the dividend is made by the Company after the meeting of the Board of Directors. However, in cases where the announcement of dividend is made after the close of market hours, the same day’s closing price would be taken as the market price. Further, if the shareholders of the company in the AGM change the rate of dividend declared by the Board of Directors, then to decide whether the dividend is extra-ordinary or not would be based on the rate of dividend communicated to the exchange after AGM and the closing price of the scrip on the day previous to the date of the AGM.
In case of declaration of " extra-ordinary " dividend by any company, the total dividend amount (special and / or ordinary) would be reduced from all the strike prices of the option contracts on that stock.
The revised strike prices would be applicable from the ex-dividend date specified by the exchange.

Now of course, this is with relation to option contracts. I don’t know how someone can reduce the impact for futures?

Even assuming that 24 Rs. is removed from your future profit, if that is what would be done in this day, I think it still makes sense to short, because

a) It does not take DDT into account, which in this case is as much as 4 Rs.

b) It does not take into account the huge increase in price today (which may have happened because of dividend stripping or such considerations).

Again, if someone can educate me as to how the future gets adjusted, I would be grateful.

Regards
Samir

1 Like
5

Dear Mayank

I don’t think that you and I are saying anything very different in terms of what the likely price ex-Dividend would be.

We differ on essentially two things:

a) I feel that the cum-dividend price to be considered before subtracting the dividend should be the price on the day before the announcement, because on the day after the announcement, other considerations, like dividend stripping take over.

b) I feel DDT needs to be taken into account, since it now nearly 20% of the dividend paid, and as far as Hindustan Zinc is concerned, certainly its price reflects both its underlying business, plus the huge cash it holds. If you reduce this cash by half by such a dividend, then the price needs to fall by the Dividend+DDT.

Otherwise, of course, there is need for a margin of safety, because of the “mood of the market” and “random noise” considerations.

In any case, I have shorted the futures at an average shorting price of 185.4. The close today was 181.2 or something, which kept me in profit. But we will see on the ex-date.

6

Hi Samir,

As I write this the prices are as follows :

Normally when a dividend is declared the future starts trading at a discount to the underlying share to the extent of the dividend. However in case of dividends exceeding 10% of underlying price, the futures price is adjusted as per NSE notice. This is reflected in the above table where the impending dividend is having no effect on the futures price. The market is expecting underlying price to fall (in general, not because of the dividend) so April future is 1.15 Re lesser and May future is 2.15 Re lesser than the underlying price.

Since you shorted futures at 186.5, if you square off your position post ex-dividend date then your shorting price would be considered as 186.5-24 (not sure about the DDT) = 162.5. And you would make a profit only if you buy below 162.5 (less transaction costs of course). Even if you want to take a position because of DDT, you are assuming that in the one week to ex-div date the price will not move adversely by 4 Rs. (~2%), which is not risk free at all.

Also, the price will adjust on ex-dividend date which is 6 April here, 7th is the record date.

The cum-dividend price to be considered will be / is the closing price the day before the ex-div date, 5th april in this case. There is price movement from dividend announcement date to ex-div date which depends on a lot other factors (e.g. if zinc prices in global commodity markets rally 20%, would the underlying price not go up?).

In short, no free lunch here.

7

Thanks for the clarification.

For now, I am holding on to these shorts. Will review on Monday.

Regards
Samir

8

Hindustan Zinc - Special Dividend F&O adjustment
FAOP32132.pdf (182.7 KB)

9

Ok, I squared off the shorts, losing 2-3 Rs. per share in the bargain.

Lesson(if it was needed): There is no free lunch!!

3 Likes
10

Hi @samir_brd

Thanks for updating the thread. It was helpful.

I also went ahead with a proprietary arbitrage strategy, as indicated above, based on the premise that there would not be any free lunch and adjustment would be smooth.

The result was on expected lines and satisfactory. Also got ~1% (after all transaction cost) additional gain over the expected arbitrage due to market fluctuation owing to pure luck :slight_smile:

Best

11

CONFERENCE CALL - from Capital Markets

ExpectsFY17 tax rate to higher than MAT

Share of mined metal production from underground likely to reach 60% in FY17
Hindustan Zinc conducted a conference call on 22April2016 to discuss the financial performance for the fourth quarterended March 2016 and fiscal year ended 2016and way forward. Mr Sunil Duggal, Chief Executive Officer of Hindustan Zinc, andMr. Amitabh Gupta, CFO of Hindustan Zinc,addressed the conference call.

Highlights of the Concall

  • The Company has posted 8% rise in the net profit to Rs 2149.13 crore in spite of 24% dip in income from operation at Rs 3132.39 crore for the fourth quarter ended March 2016. The decline in topline was due to drop in LME prices, zinc metal production partly offset by higher volumes of lead and silver and rupee depreciation. OPM shrank by 690 bps to 41.8%, due to rise in cost of production. Thus, operating profit (OP) declined by 35% to Rs 1308.11 crore. Net profit increased by 8% to Rs. 2,149.13 crore, helped by higher other income due to mark to market gains on investment income. Additionally, the provision for tax during the quarter was negative largely on account of substantial liquidation of investments at year end for payment of special dividend; the corresponding realised profits were set off by carried forward tax losses, significantly lowering the tax for the year.
  • The Company mined metal production during the quarter was 188K MT, 30% lower as compared with a year ago. The decrease was on account of lower production primarily from Rampura Agucha open pit as per the mine plan, which was partially offset by record production from all the underground mines especially Sindesar Khurd and Kayad mines, also resulting in higher lead and silver volumes. For the full year period, mined metal production wasmarginally higher at 889 MT, in-line with guidance.
  • Refined zinc metal production during the quarter was 29% lower y-o-y and 25% lower than Q3 in-line with the mined metal production. Integrated lead and silver metal production during the quarter increased by 16% and 65% respectively compared to corresponding prior quarter primarily due to higher volumes from the silver rich Sindesar Khurd mine.
  • Refined metal production during the year was higher than mined metal production primarily on account of conversion of existing mined metal inventory and enhanced smelter efficiencies. Integrated zinc, lead and silver metal production during the year increased by 5%, 33% and 58% respectively from previous year.
  • The zinc metal cost of production per MT before royalty during the quarter was Rs. 58,044 ($853), higher by 4% from a year ago in dollar terms and 14% in rupee terms. The increase was due to lower production volumes from Rampura Agucha open cast mine in accordance with mine plan resulting in lower average grades. This was further accentuated by higher mine development, partly offset by lower coal & commodity prices.
  • For FY 2016, net zinc metal cost per MT before royalty was Rs. 52,646 ($804), which is 8% lower in dollar terms and marginally lower in rupee terms due to higher volumes of integrated production, better smelter efficiencies, lower coal & commodity costs, partly offset by lower average grades due to change in mining mix and higher mine development.
  • The Company cost of production (excluding royalty) expects to remain stable in FY17 despite of lower grade metal output due to change in mining mix and recent commodity price downturn. This is as the company has to re-negotiated most of the contracts at favorable rates.
  • During the quarter, Zinc prices declined 19% to $1679 per MT, Lead prices eased 3% to $1744 per MT and Silver prices decreased 11% to $14.9/oz. Integrated saleable zinc production during the quarter dropped 29% to 154K MT, while lead and silver metal production increased 16% to 38k MT and 65% to 122 MT, respectively, compared to previous year. The Indian rupee depreciated by 8% to 67.5 per US dollar.
  • The Company expects 100% of the production volume in Q1FY17 likely to come from underground mining, given the company is trying to position itself from open cast mining to underground mining.
  • The Company achieved total mine development of 15,638 metres during Q4FY16, up 24% over a year and taking the annual mine development to an all-time high of 56,573 metres, up 18%.
  • Rampura Agucha decline development rate increased considerably during the quarter, reaching an all-time record of 1,425 metres in March 2016. Ore production at Rampura Agucha underground mine from stopes commenced during the quarter and Paste fill plant was commissioned. In the main shaft sinking project, focus has shifted to off shaft development work at the depth of 860 metres of the final depth of 950 metres.
  • At Rampura Agucha open cast mine, work for deepening of pit by additional 50 metres (referred as ‘Stage V’) is progressing satisfactorily.
  • Work is at full swing for the new 1.5 mtpa capacity mill at Sindesar Khurd mine, which is expected to be commissioned by end of the financial year. Main shaft sinking has been completed up to the ultimate depth of 1,052 meter even as off shaft development continues to be ahead of schedule.
  • Kayad mine surpassed the targeted production capacity of 1 mtpa during the quarter. The debottlenecking of the existing mill at Zawar is progressing well and will increase the capacity to 2.7 mtpa by year end.
  • The Company gross addition of 25.3 million MT were made to reserve and resource (R&R) during the FY16, prior to a depletion of 10.5 million MT, adding further to R&R. Total R&R at March 31, 2016 were 389.9 million MT containing 36.1 million MT of zinc-lead metal and 1,007 Moz of silver. Overall mine life continues to be 25+ years.
  • The Company’s share of underground mined metal production increased from 28% in FY 2015 to 40% in FY 2016. The Company expects share of mined metal production from underground mine to climb to around 60% in FY 2017 while the cost of production excluding royalty is expected to remain stable. Sindesar Khurd and Kayad mining projects continued to outperform even as Rampura Agucha underground project picks up pace with record mine development towards year end.
  • The Company expects mined metal production volume to grow in single digit in FY17 and to reach 1.2 MTPA mined metal production capacity within the next three years.
  • The Company expects mined metal to be higher in FY 2017 from FY 2016. Similar to recent years, quarterly variations in production is expected due to waste and ore sequence at Rampura Agucha open cast mine partly offset by ramp up of underground mines. Production during second half of the year will be much higher than the first half; in the first half, Q1 will be much lower than Q2. Volumes will gradually ramp up as the year progresses, as per mine plan. Integrated lead and silver metal production in FY 2017 will be higher from FY 2016, while integrated zinc metal production will be at similar levels of FY 2016 due to skewed availability of zinc mined metal.
  • The Company expects silver production to go up to 475-500 tonne, given mining in Sindesar Khurd (SK) is likely to increase to the level of 3.75 mtpa
  • The Company expects tax rate to be higher than the MAT (> c.20%)
  • The Company expects global zinc demand to rise at 2-3% p.a. whereas domestic demand is expected to increase at 4-5% p.a. Zinc premium is expected to increase further whereas lead premium expected to remain flat.
12

Read the highlights of the conference call as posted by @crazymama above, but being new to the stock market, I didn’t really understand what to make of it overall, so if someone can help me here I would be highly obliged.

I noted a few points like decrease in mined metal and refined zinc production y-o-y, but increase in integrated lead, silver, zinc. Also that cost of production of zinc has gone up by 14% in rupee terms and few other details. Also that the demands are likely to increase 2-3% globally and 4-5% domestic.

But I have no idea what to make of all this, can anyone please help me ?

13

Hello @AVB

IMHO, it is better to acquire first hand knowledge and with that in mind, would highly recommend to read a VP favorite - “The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market” - Pat Dorsey.
Apart from the basics, it provides detailed industry dynamics for different sectors - financials, healthcare, utilities, etc…

While Chapter 24 should help you with ur queries posted above, the book by itself is an excellent starting point for any long-term investor.

If you want the short and concise summary, do have a look at http://www.valuepickr.com/basics/stock-analysis-valuation-frameworks/stock-analysis-framework/

Regards

5 Likes
14

Hi ,
HZL is hitting new highs every day,Good traction is coming in the stock recently.
Technically also chart is looking good.

Pasted image1440×900 179 KB

15

I like Hindustan zinc as an investment idea with medium term horizon of 2-3 years for following reasons:

1) Global favourable Demand supply balance:

April 2017 Forecast pdf file.
The revelant extract from Page 3 on global Zinc Demand supply
“Regarding the global market balance, despite the expected increase in zinc mine
supply the Group continues to anticipate that global demand for refined zinc metal
will comfortably exceed supply in 2017. The extent of the deficit is forecast at
226,000 tonnes.”
Global Lead Demand supply
World Refined Lead Metal Balance
“Having taken into account all of the information received from its member countries
in recent weeks, the Group anticipates that there will be a close balance between
global refined lead metal supply and demand in 2017 and that reported inventory
levels of refined lead metal will therefore remain at a level similar to their current
total.”

2) Cost competiive player with Global scale of operation, Captive largest mine with among best quality ore strengthening position

image.png1116×458 54.6 KB

image.png1137×838 63.9 KB

3) Superior quality of Ore
Hindustan Zinc Mine production data from FY16 annual report

image.png1112×533 42.5 KB

Average Feed grade is 7.9% for Zinc during FY16.
However, same for peer being around 4.25% for Zinc over CY14-16 period as shown in slide 11 of enclosed persentation.
https://www.trevali.com/site/assets/files/2206/trevalipresentation.pdf

Please note that I am not mining expert and also possiblity of selective information bias in presented information. My access is limited to google search and it may be possible that there might some suprior peer with feed grade better than Hindustan Zinc.

4) Superior Cashflow generating business:

image.png1094×325 35.7 KB

The company can generate EBITDA of around Rs 7,000 Cr of with expected Capex of around Rs 2,500 Cr for proposed expansion, giving free cash flow of around Rs 4,500 Cr. This is without considering any benefit of capex and price increase in Zinc. Assuming same being distributed, the company can easily declare divided of Rs 10 per share (Equity capital of Rs 845 Cr with face value of Rs 2 per share). At current market price of around 240, same give dividend yield of ~4%. We are not taking into consideration Rs 16,000 Cr worth of liquid investment on company balance sheet as on March 31 2017.

Financial
Market Cap.: ₹ 98,175.29 Cr.
Current Price: ₹ 232.35
Book Value: ₹ 108.16
Stock P/E: 11.81
Dividend Yield: 11.96%
52 Week High/Low: ₹ 333.20 / ₹ 164.40
Return on capital employed preceding year: 66.47%
EVEBITDA: 8.03
http://www.screener.in/company/HINDZINC/

KEY RISKS

  1. Vedanta group holding the largest stake with around 65% stake with nearly 30% being held by Govt of India. Vedanta has first right of refusal when GOI decide to divest the balance stake in the company. In case GOI divest the stake, the company would be fully controlled by Vedanta group, which is past have not treated minority sharheolder fairly on various occassions. However, at the time of divestment, the minority shareholder also can expect open offer. Current management of the company is under control due to GOI representation on the Board.
  2. Decline in Zinc demand/price at LME and/or rupee appreication may signficantly affect cashflow generating ability of the company.
  3. High regional concentration of mines in Rajasthan State, Udaipur district. Most of Ore for zinc and lead is mined in Udaipur district. Any problem like earthquake, flood or riots in the region can majorly hurdle company performance
  4. Enviorment issue: The mining and smelting of zinc is not very environment friendly and hence may face issue from Ministry of enviorment in future.

Disclosure: The company is among my Top 6 holding. Investor are advised to do their own due diligence before making any investment. My view may be biased due to my investment and also limited understanding of sector and company.

7 Likes
16

I held mostly Oil, Metal & Mining Stocks in my portfolio for the last year and half. Sold all my Oil holdings (Cairn India, another Vedanta company, was the best performer among the lot). Recently sold all my shares in HINDZINC for the following reasons:

  1. Zinc’s current price is higher compared to average historical price. There’s some correction in the last few months, but its still quite high. Zinc Historical Prices: https://tradingeconomics.com/commodity/zinc

  2. Voluntary production cuts by global biggies could lift a very low Zinc price, but may not be able to sustain high prices. Crude Oil, a similar story, is already struggling in spite of production cuts by OPEC and Russia.

  3. HINDZINC’s latest result was their best quarterly result ever. Analysts don’t expect it to perform at such level for the next few quarters.

  4. Vedanta management is still a concern although GOI’s holding should keep it under check. Cairn India merger is the most recent example of them not doing the right thing by the minority shareholders. They will continue to extract maximum dividend possible from HINDZINC, which is mostly a good thing for retail investors.

While I feel Crude oil price increase is done, I still feel metals & mining still has some legs. I will bite into HINDZINC, NMDC, GMDC, NATIONALUM if their stock prices fall further.

Disc: Just my opinion, not investment advice. Definitely not a sector expert. Willing to change my opinion if an expert disagrees.

3 Likes
17

Hello VPs!

The FCF of the company is around 32350 Crs.

The per share FCF comes to approx Rs 77 and the CMP is around 237.

How do we analyze this scenario? On one hand, you are buying the share for a discount Rs 77.
On the other, why is the company sitting on so much cash and not disrtributing/utilizing it? Is it a sign of stagnancy?

18

@vasuadiga

Appreciate your view on the company. Find enclosed my point on some of the issues:

  1. In the same link you shared, please increase the tenure to 5-10 years and one would get completely different picture. In 2006, LME Zinc price were upwards of USD 3000, as against current market price of around USD 2400. In my understanding, what drive commodities prices in medium term is demand suply balance and not past price range. If, demand supply situation is favourable, commodities price would rise and would reach new high.

  2. This is not a monopoly or oligopolgy. The mines were closed due to lower price/ operating issue. So there are some mines closed while some new operational. Find enclosed International Zinc And Lead Study group Feb 15 2017 which highlight that despite closure of mine in 2016, overall production of ore was at same level as 2015.
    ILZSG Feb17 Zn.pdf (149.3 KB)

  3. Market would have difference of opinion. Further, first three quarter in FY17 were also not great for the company. Hence, rather than just looking at 4th quarter number, it would make sense to look at Full year number. I have access to ICICI Direct report which does project EPS increasing from Rs 19.7 in FY17 to Rs 23.9 in FY18 and Rs 25.5 in FY19. So kind find 14% CAGR growth in EPS over next two years.

  4. I agree with you on conern on management. However, Vedanta is majoly depedent on Cashflow support for Hindustan Zinc. Hence, we shall expect continued large dividend disbursement for the company.

Last but not least, every individual shall consider once own risk profile and goal and decide investment strategy. I appreciate your transprency and ability to highlight critical issues. Let us all of achieve our goal on path carved out by us, at time, it may be completely opposite!

Discl: My view may be biased due to my holding. The investor shall do his/her own due dililgence before investing.

3 Likes
19

Very useful insight about Galvanised steel end use globally and India likely growth prospect. The analysis is bit old, but very relevant. With increasing focus on afforadable housing, zinc demand may get additional growth from construction which account for 42% of galvanised demand. Even outlook for Automobile and consumer durable, also good for medium term.

Also, refer to one Slide 13 for trend in Galvanised steel demand as a per cent of total steel consumption in China. It increased 18% in 2000 to 19% by 2020. Among all segment of steel, Galvanised steel is expected to register highest CAGR during 2010-2020 period in Steel demand for China growing at 4.6% p.a. as projected in the presentation.

Welcome to get view of other member on Zinc sector outlook
http://www.zinc.org.in/wp-content/uploads/sites/3/2014/07/Sankhe-Zn-and-Steel-Outlook-India.pdf

Global Demand supply situation continue to remain in deficit

image.png931×522 63.4 KB

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Excellent presentation, although old, providing rationale for lower zinc demand with details about likely potential mine supply addition.
https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0ahUKEwi5_eD73tPUAhUJu48KHWESDuoQFggmMAA&url=http%3A%2F%2Fwww.metalicity.com.au%2Fsites%2Fmetalicity.com.au%2Ffiles%2Ffiles%2FWoodMackenzie_PDAC_ZincRagstoRiches_Mar2015.pdf&usg=AFQjCNEHwJPbWfKqTb7XCmJ6lrXoaNKF4A

Key slide and observation:
Slide 3: Limited indsutry profitability for minor prior to 2006 affected future growth capex by them
Slide 6: Projecte demand supply balance (old March 2015 estimate). By 2020, nearly 3.8 mn tonnes of mine capacity required, while Development of the entire population of proabable projects could deliver 2.2 mn tonnes of this requirement, with Capex of USD 8.4 billion. When we put this in context to Slide 3, we understand why it would be difficult for miners to do the capex required.
Slide 8: Change in industry composition, with experience players are doning limited capex due to past experience and small and mid size with limited operating experience expected to provide for new supply.
Slide 13: Providing details of all new large base capex and porabable mine expansion.

One more slide from old compilation of Wood Mecknesie on Global deficit and stock days for zinc

image.png878×538 37.4 KB

Jan 2017 Zinc sector demand supply price outlook by Royal Bank of Canada
https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0ahUKEwi7toag49PUAhUKro8KHQDTBf0QFggqMAE&url=http%3A%2F%2Fwww.rbc.com%2Feconomics%2Feconomic-reports%2Fpdf%2Fother-reports%2Fcpm.pdf&usg=AFQjCNFfwbueS5mIpKnaBegH08WaSHvw2A

Discl: I hold Hind Zinc share and my views might be biased.

1 Like