Hindalco: Hold. Hindalco Industries: Down but not out

Stocks of global metal producers are being hammered due to the meltdown in prices. The BSE Metal index is down over 35 per cent since the start of 2015. Among those worst hit is aluminium major Hindalco Industries (Hindalco) whose stock price has been cut by half over this period.

The stock’s poor performance was due to a few reasons. One, aluminium prices are down over 20 per cent in the last year and the metal forms the mainstay of the company’s revenue. Over-supply from China could lead to continued price pressure in the near term. Two, operational performance of its Indian units in the June quarter was weak.

While metal production increased nearly 40 per cent year-on-year, profits slipped due to lower realisations, aggravated by higher input costs, depreciation and interest expenses.

The management has indicated that profitability impact may last for a few more quarters.

Three, the company’s US subsidiary, Novelis, which contributes 50 per cent of its consolidated revenue, reported lacklustre results in the June quarter. Sales dipped 2 per cent Y-o-Y and the subsidiary reported a loss.

Falling aluminium prices may continue to dent profits due to inventory losses in the near term. But after the fall in price, Hindalco’s stock is inexpensive. The stock trades at 0.4 times its estimated 2015-16 book value.

This is much lower than that of global peers such as Rusal and Alcoa (trading at 0.7 to 0.9 times price to book) and local peer Nalco (trading at 0.6 times price to book). It is also lower than its historic price-to-book ratio of about one time in the last five years.

Shareholders can remain invested as the near-term negatives seem to be priced in and the company’s long-term prospects remain strong.

A weak rupee will benefit the company. Also, any hike in import duty (from 5-10 per cent) as demanded by the industry should help.

That said, the cheap valuation does not make the stock a buy candidate as it lacks near-term price triggers.

Hindalco’s margins are under pressure and there may be no respite in the near future. For one, after the company lost its captive coal blocks in April 2015, it had to purchase fuel at higher prices; input costs increased 45 per cent Y-o-Y in the June quarter.

While the four coal blocks it won in recent e-auctions can take care of one-fourth of its coal requirements, margins may remain dented until production starts (over the next two quarters). Also, interest cost increased 78 per cent Y-o-Y in the June quarter as new capacities became operational.

Depreciation expenses increased sharply — 40 per cent year-on-year — in the June quarter. These factors would continue to put pressure on net profit which dipped 67 per cent in the June quarter.

Profits at its US subsidiary Novelis — the world's largest recycler of aluminium — were affected primarily by falling aluminium prices which led to inventory losses.

Also, ramp up in costs for its new automotive capacity impacted profit.

Hindalco’s long-term prospects, however, remain strong. Its copper segment, which contributes about 15 per cent of operating profits, faced revenue pressure from falling metal prices. However, thanks to better smelting margins, profits improved Y-o-Y in the June quarter by 8 per cent.

This segment should see consistent growth as refining margins are expected to be robust.

Its Utkal alumina refinery plant — among the low-cost plants globally — is operating at nearly full capacity utilisation.

The Aditya smelter’s utilisation is expected to improve from about 55 per cent levels currently to full capacity by the end of the financial year.

Also, margins should improve in the long term as captive coal output ramps up.

Uptick in aluminium demand from the automotive segment to meet stricter global emission standards should boost revenue and profits for Novelis. The company has debt of about ₹60,000 crore and it may remain at these levels with the capex cycle nearing an end. The company's net debt to equity is about 1.7 times.

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