Growing domestic demand, improving profitability of its overseas subsidiary and upcoming capacity expansion are strong points.

Adarsh Gopalakrishnan

Investors may consider buying shares in metals major Hindalco as upcoming greenfield capacity in an expanding domestic market and improving profitability at its overseas subsidiary Novelis provide good potential for growth. Hindalco trades at Rs 204 (P/E 9.2 FY10) which is at a discount to peers such as Sterlite Industries (P/E 14.2 ) and NALCO (P/E 27 ).

Domestic expansion

With aluminium consumption in India expected to grow at 9 per cent per annum over the next four years, thanks to increased demand from power, automotive and infrastructure segments, Hindalco's expansion plans are expected to boost its growth prospects. The segment accounted for 11.7 per cent of the group's consolidated sales in FY10, has operating margins of 25 per cent and contributed to 25 per cent of consolidated operating profits.

Currently, the company's fully integrated domestic operations have the capacity to produce 1.5 million tonnes of alumina, smelt 500,000 tonnes of aluminium, and process 236,000 tonnes of value-add products.

The company is expected to add significant greenfield as well as brownfield capacity, which by late FY12 will double the company's alumina output and take smelting capacity to 1.28 million tonnes per annum.

These additions are expected to boost the group's consolidated profit margins, thanks to the increased volumes of the more profitable domestic operations. The increased volumes of aluminium metal will also act as a hedge to possible high raw material costs in Novelis which are linked to volatile London Metal Exchange aluminium prices.

Novelis' comeback

The last three quarters have seen improving performance at the company's Novelis operations, thanks to the expiry of a largely loss-making fixed-price contract in December 2009. Operational measures such as improved product mix, better inventory management (enabling pass-through of material cost increases) and use of cheaper recycled aluminium have resulted in improving profitability.

Operating profits have more than doubled in the first quarter of the current fiscal to $263 million and Novelis has paid back debt of $50 million.

With around 50 per cent of Novelis' consumers coming from defensive sectors such as food and beverage, volume-led demand is likely to remain steady. North European markets (lead by Germany, thanks to growing exports) have shown signs of a recovery.

This could help counter to a limited extent, weakness in Southern Europe and a stagnant US market. A positive for the company is the strong presence in robust Asian and South American markets lead by Brazil (where Novelis is doubling its rolling capacity at a cost of $300 million).

Novelis currently has 29 rolling plants in North and South America, Europe and Asia which processed 2.7 million tonnes of aluminium products in FY10. The segment accounted for 67.5 per cent of the group's consolidated sales and 60 per cent of the operating profits during the same period. Operating margins at Novelis stood at 10.2 per cent during FY10.

Pricing pressure

At current price of around $2300 per tonne, aluminium prices are up around 15 per cent in the last three months but still remain 30 per cent off their FY08 peaks. The sector is undergoing a ‘consolidation' phase with several inefficient old smelters shutting down across the globe and new capacity coming up in India, Middle East and China.

With smelter capacity exceeding demand, prices are expected to see limited upside from the current levels for the next two years.

On the downside, prices may find some support at $1850-1950 per tonne as these levels may see several high-cost Chinese smelters cutting production to stem loses. With a cost structure that places it in the lowest quartile among global smelters, Hindalco has a lot more ‘staying' power compared to more cost ineffective, less integrated global smelters.

Copper blues

Although copper prices have recovered to within 9 per cent of their FY08 peak, copper smelters such as Hindalco may not benefit much. Hindalco derives its profits in the copper business from concentrate treatment and refining charges (CTRC) — on fixed charge basis — which have been low for the last six months.

Copper concentrate producers are expected to have an upper-hand over smelters in pricing until new mine capacity comes on-stream in 2014 and 2015.

Demand for copper in India is expected to grow at 7-8 per cent per annum for the next five years, which might result in higher capacity utilisation levels.

The company currently has 500,000 tpa of copper smelting capacity and 142,000 tpa casting facility. This segment accounted for 20.6 per cent of consolidated group sales and 9.4 per cent of operating profits in FY10. Segment operating margins stood at 5.2 per cent.

Improving Financials

Hindalco has seen consolidated sales rise in FY09 before dipping in FY10(Rs 60,562 crore), mainly due to highly volatile LME aluminium prices and a protracted period of sub-par demand in developed markets. Profits (Rs 4,349 crore) have rebounded strongly in FY10 helped by a turnaround in Novelis, after taking a sizeable hit in FY09 on account of losses and write offs at Novelis and slipping Aluminium realisations.

The first quarter of this fiscal was good as standalone sales and profits were up 33 per cent and 11.2 per cent respectively with EBIDTA margins of 17.5 per cent compared to the same quarter last year because of improved aluminium realisations.

Novelis reported that its EBIDTA and shipments were up almost 10 per cent each owing to higher realisations and off-take for the latest June quarter.

The company's gross debt as on March 2010 was around Rs 24,000 crore with a debt equity ratio of 1.2. However, the company's consolidated FY10 EBIT covered interest 6.6 times over. The company's greenfield plans are expected to cost Rs 40,000 crore, of which, an estimated Rs 20,000 crore has been committed to ongoing projects.

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Hindalco unveils major investment plans
Hindalco Industries Q1 net profit up 11% at Rs 534 cr

(This article was published in the Business Line print edition dated October 3, 2010)
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