Stock Fundamentals

Hindalco Industries: Buy

Adarsh Gopalakrishnan | Updated on November 12, 2017

The company’s improved global operations have the potential to weather theongoing storm in aluminium prices better than its peers.



The domestic aluminium operations with better margins will be the key driver for both sales and profit growth.

Investors with a long-term perspective can consider buying shares in aluminium major, Hindalco Industries, despite upheavals in the global economy and the likely pressure on commodity prices. The company's integrated domestic aluminium business and the much-improved global operations (Novelis) have the potential to weather the ongoing storm in aluminium prices more effectively than global peers.

A 25 per cent slide in the stock's price in a span of six months has Hindalco trading at Rs 134 (P/E 10.8 times consolidated FY11). This is at a discount to domestic peer, Nalco (P/E 15.6). Also, given its superior margins and large expansion plans, Hindalco's EV/EBIDTA of 6.5 times compares favourably to that of international peers such as Alcoa, Chalco and Rusal.

Domestic expansion

Aluminium consumption in India grew at a scorching pace of 14 per cent in 2010-11, better than the anticipated 9-10 per cent growth. This pace has been the incentive for Hindalco, Vedanta (Sterlite Industries) and Nalco to embark on significant capacity additions in alumina and aluminium metal.

Alumina produced from bauxite is a key input for aluminium metal production. Hindalco plans to add significant capacity over the next five years, which will see alumina capacity quadrupling and aluminium metal production trebling from the current levels.

The company has faced delays in commissioning its Utkal alumina refinery project and smelter due to problems related to land acquisition and coal-mine allocation, among other issues. Despite this, Hindalco, thanks to its first-mover advantage in setting the ball rolling, remains the best placed among the top-three Indian aluminium producers to capitalise on growth in Indian aluminium consumption.

Over the next three-five years, Hindalco's domestic aluminium operations with better margins (relative to copper and international re-rolling), will be the key-driver for both sales and profit growth.

With revenues of around Rs 8,000 crore in FY 11, the company's domestic aluminium operations accounted for just over 10 per cent of group sales. However, clocking in EBITDA of Rs 2567 crore, this segment contributed to around 30 per cent of consolidated operating profits.

Despite cost pressures such as higher domestic coal prices, the company's captive bauxite and coal mines coupled along with captive power generation make Hindalco's domestic alumina and smelter operations among the lowest cost globally.

The domestic aluminium operations operated on EBITDA margins of 32 per cent in FY11. Recent reports indicate that the company is close to securing clearances to mine at the Mahan Coal block; this would be a major boost to the company's expansion plans. Power generation and alumina cumulatively account for over half the cost of producing aluminium metal. Producing both cheaply could be Hindalco's ace up the sleeve. Hindalco's domestic arm includes copper operations which produce copper cathodes, sulphuric acid and a limited quantity of precious metals.

While these operations earn close to double the revenues of the domestic aluminium operations, the segment's operating profits were less than a third of the domestic aluminium operations. This is due, in large part, to operating on a pre-negotiated Treatment and Refining Charge (TCRC), which restricts realisations.

Global operations on rebound

Novelis buys aluminium metal from external sources and processes them by rolling or drawing into beverage cans, auto-parts and consumer electronics. Substitution of steel with aluminium and use of aluminium by the auto-industry, support prospects for Novelis.

About 50 per cent of Novelis' clients are in the relatively defensive food and beverage space, which may prove an effective hedge in volatile times. During the last fiscal, Hindalco completed an aggressive round of refinancing, which involved Novelis returning capital to the parent entity andlowering long-term borrowing costs.

Novelis now looks well-prepared to expand existing rolling capacity by over 30 per cent over the next four years, focusing on developing regions in Asian and South America, where per-capita consumption of value-added aluminium products show good scope for growth.

The subsidiary shipped out 10 per cent more aluminium products in FY-11 compared with the previous year. Novelis' sales were up by 22 per cent to over Rs 48,000 crore which accounted for around 67 per cent of consolidated sales. Operating profits grew by 42 per cent to just under Rs 5,000 crore, accounting for around 60 per cent of consolidated operating profits.

Aluminium prices on the London Metal Exchange, based on which the company prices its products, are down by nearly 20 per cent since mid-April. Weakness in Europe and the US, and an imminent manufacturing slowdown in China have all contributed to the slip. Working in Hindalco's favour though are two factors: The cost of its Indian operations are among the lowest in the world.

Aluminium prices are approaching levels which could spark capacity shutdowns among cost-intensive producers stemming downside in prices. The second factor is that Novelis (which contributes to the bulk of the company's profits)may actually benefit from falling aluminium prices as a re-roller.

Financial overview

A solid showing in terms of volumes (both domestic and international) and 20 per cent higher average aluminium prices in FY-11 compared with the preceding fiscal led to Hindalco's consolidated sales moving up by 19 per cent to Rs 72,000 crore. The company's core EBIDTA grew by 25 per cent to Rs.8700 crore. Net profits slipped from Rs 3,925 crore in FY-10 to Rs 2,456 crore in FY-11.

However, this is mainly due to a one-off derivative gain (Rs 2,700 crore) in FY-10 compared with a loss of Rs 300 crore in the recent fiscal. Gross debt levels have risen by over Rs 3,700 crore to Rs 27,691 crore, taking the debt-to-equity to around 0.96 times in FY 11. The company's EBIT covered interest a reasonable three times over.

Published on September 24, 2011

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