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Buy Sterlite + Hindustan Zinc

August 1, 2007

Citigroup has initiated coverage on Sterlite Industries with a BUY 1M [Medium Risk] rating and a price target of Rs 910, potential upside of 45% from CMP of Rs 621.

Sterlite is a conglomerate producing non-ferrous metals – zinc,aluminium and copper. Zinc is Sterlite’s best-performing business. Prices have been relatively subdued this year, but supply from China to moderate over the coming months, enabling prices to recover in 2HFY08 to ~US$4,400/t. Citi sees upside to FY09E forecasts, based on buoyancy in zinc and lead prices. Despite flat aluminium prices, Citi expects moderate earnings growth in Balco, in which Sterlite currently owns 51%.

Sterlite operates a copper smelter for which the key profit driver is TC/RC margins, which are expected to halve from FY07 levels to 14-15c/lb, and EBITDA from Rs11.6bn in FY07 to ~Rs8bn in FY08E-FY09E. Given this, and sector re-rating, Citi values Sterlite Industries stock at a P/E of 10x FY09E, a premium to historical valuations.

Hindustan Zinc Ltd [HZL]:
Citi has initiated coverage on Hindustan Zinc with a BUY recommendation and a price target of Rs 1155, potential upside of 62%.

HZL is a fully integrated, low-cost zinc producer which meets all zinc concentrate requirements internally; offering exposure to the robust zinc price outlook. HZL also offers volume growth, scope for cost cutting, and exposure to buoyancy in lead prices.

Production costs are low as 90% of ore is sourced from its low-cost Rampura Agucha mine. Ongoing capex should enhance zinc capacity by 63% from 411,000t to 669,000t by 1Q FY09, useful at a time when zinc prices are likely to revive.

Based on outlook and sector re-rating due to global M&A, our target is Rs1,155 based on a P/E of 10x FY09E.

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