The Vedanta group’s cash cow Hindustan Zinc was first off the mark in the group’s restructuring process. Recent news reports had indicated that the group will use the demerger route to split the group’s businesses into separate entities, to unlock value and also manage its debt burden.
Hindustan Zinc’s board has authorised a committee of directors to evaluate splitting its fully integrated zinc production facility into three units — zinc & lead, silver and recycling.
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Now, a conventional demerger splits different businesses into different entities. Here, one would have thought Vedanta would split its iron and steel, aluminium and oil and gas businesses (as reported earlier) into separate entities. These could then be valued separately based on their business fundamentals, the commodity cycle and the holding entity’s profitability and balance sheet. The sum of these parts would then add up to be larger than the whole. And, as mentioned in our analysis in Moneycontrol Pro, the demerger would likely release cash for the group, as the intention is to raise cash to service debt or even lower it.
But, it’s not clear how separating an integrated operation into separate companies and then listing them can create value for shareholders. In the production process for zinc, lead and silver are also obtained. It’s not very clear what the recycling part will be and one needs to wait for the restructuring proposal to understand this part better.
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The structure will likely mean the creation of related-party transactions as the silver unit will have to pay the lead & zinc unit for the raw material from which the silver is extracted and processed. This may be based on the value of the underlying metal present in the product. The valuation of these transactions will be of interest to shareholders.
The unlocking value part may come from having a standalone silver company that may enjoy a higher valuation as a precious metals company, and be influenced more by the silver cycle, rather than getting overshadowed by the non-ferrous metals cycle. In FY23, revenues from selling zinc were Rs 24180 crore, from lead Rs 3913 crore and from silver Rs 4388 crore for Hindustan Zinc. It would appear that the promoters don’t believe that the silver business’ valuation is fully reflected in HZL’s Rs 130,245 crore market capitalisation.
But, what’s not clear is if the group’s restructuring is meant to help them manage their debt burden better, how will this structure end up releasing cash for the promoters? Could the promoters be contemplating selling part or all of their stake in the silver company and then use those proceeds to meet their debt obligations?
These are questions for which answers are likely to become clear once the actual restructuring proposal become public, assuming it goes ahead. The government as a significant shareholder is likely to have its own view on the subject. After all, the proposal to sell the group’s international zinc business to the company did not happen because the government was opposed to it. Will they give the green light to this proposal, when it is formalised?
Some investors may even wonder if there’s any real need to restructure HZL. It’s a profitable cash-generating focused integrated zinc producer. It earned an EBITDA margin of 52 percent in FY23 and was debt-free till FY23 when it took on debt, as it paid out significant dividends, ostensibly, to meet the group’s funding needs. It’s a cash generation powerhouse, and In FY23, it generated Rs 15129 crore of cash on an operating profit before working capital changes of Rs 17712 crore. Free cash flow generated was Rs 11568 crore.
HZL’s shares rose to a high of Rs 317 after the announcement but then fell from those levels, its shares closed at Rs 308 with a gain of 3 percent over their previous close on Friday, September 29.
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