An accretive acquisition for Vedanta

Vedanta Resources will acquire Anglo American’s zinc assets (to be routed via Hindustan Zinc) for an enterprise value (EV) of $1.34 bn.

Online PR News – 17-May-2010 – – Vedanta Resources will acquire Anglo American’s zinc assets (to be routed via Hindustan Zinc) for an enterprise value (EV) of $1.34 bn. The assets consist of the Lisheen mine in Ireland (100% owned), the Skorpion mines in Namibia (100%) and 74% in Black Mountain Mining (BMM), which owns the Black Mountain mine and the Gamsberg project in South Africa. The acquisition would increase the group’s zinc/lead production capacity by 37% to 1.46 million tonnes per annum (tpa) or 11% of global zinc market and consolidate Vedanta’s position as the world’s largest integrated zinc and lead producer. It increases the attributed reserves and resources by 76% (206 mt) to 478 mt. Future growth would come from Gamsberg, with mineral resource of 186 mt, the planned capacity of 400 kilo tonnes per annum (ktpa) and operating life of more than 20 years.

Of the total price, the largest proportion ($698 m) is for the Skorpion mine, which has the lowest coefficient of performance ($902/tonne) of the three assets, $308 m is for the Lisheen mine and $332 m for the 74% stake in BMM. Based on the earnings forecasts by Johann Pretorius for Anglo’s zinc business, Ebitda (earnings before interest, taxes, depreciation and amortization) of 55%, CY10 EV/Ebitda is 2.9x, vs. HZL FY11 EV/Ebitda of 3.8x (63% margin).

Funding for the deal should not be a problem. As of March 31, 2010, the Vedanta group had cash and cash equivalent of $7.2 bn and HZL had $2.6 bn. As the profitability of the zinc business would be higher than the interest income earned on HZL’s cash on hand, the acquisition would be EPS (earnings per share) accretive for HZL. A quick adjustment to our earnings/cash indicates that the transaction does not materially impact our TP (target price) of Rs 1,090.

Risks (a ) Exxaro (owns 26% in BMM) has a right to match Vedanta’s offer in BMM. If this happens HZL would lose the high growth assets. )b) HZL (29.5% owned by the Indian government) will need board approval for the acquisition.

Company description: HZL is India’s only integrated zinc producer with about 80% share of the Indian market. It has open-pit mines for lead-zinc ore at Rampura Agucha and two underground mines—Rajpura Dariba and Zawar. All are in Rajasthan. Two of its three smelters are in Rajasthan—Chanderiya (zinc 525,000 tpa, lead 85,000 tpa), Debari (zinc 88,000 tpa). The third is at Vizag, AP (zinc 56,000 tpa). One of HZL’s biggest advantages is the Rampura Agucha mines, which meet 90% of its concentrate requirements. HZL has total captive power capacity of 335 mw.

HZL announced expansion plans (210,000 tpa zinc and 100,000 tpa lead) that would take total integrated zinc-lead capacity to 10.65 lakh tpa with fully integrated mining and captive power generation capacities, and make it the world’s largest integrated zinc-lead producer by mid-2010. Total capex on this will be Rs 29 bn. The zinc capacity (210 ktpa) has commenced production in March 2010, three months ahead of schedule.

Investment strategy: We rate HZL shares Sell/Medium Risk with a target price of Rs 1,090. Zinc LME prices have risen 82% over the last year. Zinc fundamentals have improved dramatically, owing to supply cutbacks and shutdown of zinc-lead smelters due to lead poisoning. However, there remains ample potential supply over the next few years, limiting price gains.

Our base case forecasts indicate a small surplus until 2014. We forecast zinc LME prices to rise 23% YoY in FY11 (to $2,375/t) and decline marginally in FY12 ($2,338/tonne). Lead LME prices are expected to grow by 12% in FY11 (to $2,212/tonne) and remain flat in FY12 (to $2,214/tonne). Based on our forecasts, we expect Hindustan Zinc’s Ebitda margins to range 70-73% in FY11-12. Despite the expected increase in margins and expected strong zinc lead volume growth (34% in FY11 and 10% in FY12), we believe that the LME price rally is priced in and do not expect much upside from current levels. Maintain Sell.

Valuation: We value HZL’s core business at 5.2x June 11 price-to-earnings (three-year trading average vs 4.7x earlier) and arrive at a value of Rs 641/share. This multiple is in line with HZL’s average multiple (5.2x) over the period April ‘07-March ‘09 when the average zinc price was about $2,300 (12-month period ending the June 11 forecast, $2,365/tonne). We add cash/share of Rs 448 to the PE-derived value of Rs 641 and arrive at a target price of Rs 1,090. At our target price, HZL would trade at a June 11 PE of 7.8x and EV/Ebitda of 3.4x....

Source: Financial Express

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