Hindalco benefiting from better pricing outlook

Further gains will hinge on global aluminium prices, debt reduction, as most positives seem priced in

The Hindalco stock scaled to a 52-week high of Rs 124.6 on Tuesday, rising more than two-fold from its 52-week low of Rs 58.2 in February. While the February lows were on the back of extreme pessimism on global growth and aluminium prices, the rebound signifies improvement in Street sentiment, supported by events.

After the Budget that supported demand outlook, proposed safeguard duty, declining costs of production, good performance by Hindalco's US subsidiary, Novelis, better-than-expected March quarter numbers of domestic business, and the recent rise in aluminium prices, bode well for Hindalco.

As London Metal Exchange aluminium prices surged to $1,600 a tonne from lows of $1,450 a tonne in January, the profit has improved. Profitability also gets a boost from the fact that costs for aluminium producers have been in a decline from $1,600 a tonne in FY16 to an estimated $1,400 a tonne in FY17, led by economies of scale, lower coal and crude oil derivative prices, etc. Economies of scale refer to a proportionate saving in costs gained by an increased level of production. US subsidiary Novelis has also been reporting good profitability (Ebitda up 24 per cent in March quarter) and reduction in net debt due to improved cash flows. Ebitda is earnings before interest, taxes, depreciation, and amortisation.

These positive developments have led to an improvement in Hindalco's outlook. But after the rally, most of these positives seem factored in and further gains will hinge on gains in aluminium prices. Indian aluminium companies with expanded capacities are exporting about 40 per cent of their produce as there is oversupply in the domestic market. Due to oversupply, benefits from measures like safeguard duty, if implemented, could be limited. India Ratings had said the duty, if implemented, was unlikely to push up profit margins significantly.

Further, prices have rebounded on the back of some capacities in China being curtailed. But, now there is a word of caution. Analysts at Kotak Institutional Equities say while deficit in global aluminium markets in recent months on weak China output has fuelled expectations on the pricing front, aluminium markets will likely go back to surplus in the second half of 2016 due to restarts and new projects in China. The unwinding of large inventories poses an equal pricing risk.

Investors need to be cautious and watch the movement of aluminium prices. The other cue to be watched is reduction in Hindalco's debt as HSBC says a cut would boost the stock.