Better days ahead for Hindalco

Winning coal blocks and improved availability of bauxite are positives for the company

The Hindalco stock has recovered recently from closing lows of Rs 138.45 last month to Rs 158 now, as the company won new coal blocks. The company's bauxite availability too has improved. Analysts believe, there could be more gains going ahead.

After the Supreme Court’s orders on coal block re-allocation and due to bauxite mining bottlenecks, the stock had gradually fallen from its 52-week highs of Rs 198.70 seen in July last year.

The recent bids for coal blocks even though appearing aggressive are important for fuel safety and profitability of its smelters, Aditya and Mahan, which have seen capacity expansions. Though the freight hikes and clean energy cess on coal is marginally negative for the company’s profitability, analysts believe the impact on earnings will be minor. Post the Union Budget analysts at Motilal Oswal Securities have tweaked earnings estimates by 1-3 per cent for Hindalco, Nalco and Sesa Sterlite after factoring in freight and coal costs. They, however, add that Hindalco remains one of their top picks in the space on the back of production ramp-up, end of capital expenditure or Capex cycle and recovery in aluminium prices.

Analysts at HSBC, too, remain overweight on Hindalco and have a target price of Rs 200 a share. The consensus target price stands at Rs 167, as per 25 analysts polled on Bloomberg since February 2015.

Hindalco had bid aggressively for coal mines in the recent auctions. While it won the Kathautia coal block at a price of Rs 2,860 a tonne ($46), it also has got the Gare Palma IV/5 coal concession at a price of Rs 3,502 a tonne ($56). Though the price appears to be on the higher side of the bidding curve, these coal blocks were crucial for Hindalco, especially post capacity expansions of Mahan and Aditya smelters. Currently, there is shortage of coal supply in the country. Coal India, already under stress to fulfil its Fuel Supply Agreements (FSAs), is also seeing decline in e-auctions. Further, the e-auction prices are not cheap either. The location of its smelters does not favour imported coal, as transportation costs will be high.

Additionally, while international coal prices are soft at present, they might not remain so for perpetuity. Thus, access to coal is the key to profitability of its capacities. Hence, the aggressive bidding is still being looked at in good light. The company has insulated itself from the vagaries of coal price variance in the coming days and notably, the mines procured are already operational and can start feeding the plants from day one.

Consider this, the Kathautia block won is an operating coal block and the distance between Kathautia and the company’s Mahan smelter is only about 220 km. Analysts at HSBC observe that adjusting for the cost of mining (around $8 a tonne), royalty payments ($6 a tonne) and transportation costs ($5.3 a tonne), the coal will be delivered to the Mahan smelter at around Rs 4,000 a tonne ($65). Adjusting for the difference in the calorific value of coal, this cost is broadly in line with the rates offered by Coal India in e-auctions.

Gare Palma, an operating coal block with approved extraction of one million tonnes per annum, is also geographically suited for the company. Given that the distance between Gare Palma and the company’s Aditya smelter is only around 130 km, Hindalco will likely utilise the coal in a blend for that smelter. HSBC analysts say the coal from this block is not as cheap as Kathautia, however, it is not as expensive as imported coal. Further, if the coal prices move up, more benefits will flow from the coal block.