Hindustan Zinc OFS sets stage for government's full exit. Here's why it's a big red flag

The wait is finally over. The government, the largest minority shareholder in Hindustan Zinc at 30 per cent, has finally gone ahead with its plan of reducing its stake in the miner. After years of delay and waiting for favourable market conditions, it is cornering around Rs 5,900 crore from selling 2.5 per cent in the zinc and silver producer through an offer for sale (OFS).

The stock has leaped a sharp 73 per cent in the past year, thanks to buoyant silver prices, ensuring a handsome reward for the government. But the OFS is a reason for someone else to rejoice too—Hind Zinc's majority shareholder and parent Vedanta. You see, Vedanta and the government don't see eye to eye. The parent, for years, has prayed for the government to divest and exit Hind Zinc, citing its interference in decision-making. The OFS looks like the government is finally ready to loosen its grip on Hind Zinc, answering Vedanta's prayers.

But if that is finally happening, Hind Zinc investors will have reasons to worry. The implications of the government's eventual exit, at some point in future, are anything but positive.

Why government's possible exit is worrying

Hind Zinc has had a stellar record of rewarding shareholders. It has delivered an average return on equity or ROE of 25 per cent in the last 10 years, while maintaining a dividend payout ratio of over 100 per cent over this period. However, in the last three to four years, the massive dividend payouts have crippled its spending on growth.

From FY21 to FY24, its fixed assets have remained muted as about Rs 61,000 crore has been flushed out in dividends. This sum is nearly 1.2 times the cash flow, which means its payouts far exceed what it is earning. The result has been that the once-cash surplus company now has more debt than cash. The culprit is Vedanta that guzzles cash from Hind Zinc via dividends and passes it on to its UK-parent Vedanta Resources to ease its massive debt pile.

The UK-parent further takes other routes of sourcing cash from Vedanta through raising its brand fee, intercorporate transactions, or direct stake sale—things it attempted with Hind Zinc, too, before they were shot down by the government. Notably, in the past, the government has rejected demerging Hind Zinc and its plans of buying an entity from Vedanta at inflated valuations (meant for sourcing funds).

The government has evidently been the formidable force stopping Vedanta from biting huge chunks off Hind Zinc's cash kitty through a number of proposals. A complete government exit will mean no stopping Vedanta anymore.

Your takeaway

While Hind Zinc remains in solid financial shape, backed by solid tailwinds for silver (its major revenue contributor), the massive dividends squeezed by parent Vedanta are weighing on the company's operations, as evident from the slowdown in its fixed assets. More money is being spent on dividends than investing for growth. This may only increase in case the government eventually does a complete exit, leaving no one to challenge Vedanta's cash extraction and impairing Hind Zinc's growth levers.

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Disclaimer: This is not a stock recommendation. Investors should do their due diligence before making any investment decision.