Hindalco: Not out of the woods yet

Though the expansion bodes well for volumes, subdued aluminium prices, lack of backward integration of coal will impact profitability in FY14

Aditya Birla Group, in a move aimed at increasing capacities nearly three-fold, sees its Indian operations under Hindalco start trial runs of the 359-tpa (tonnes per annum) Mahan aluminium smelter and the 1.5-tpa Utkal alumina  project. The start of the first two planned expansions is sentimentally positive and will add to volumes growth in FY14, analysts say.

The company even plans of commissioning its 359-ktpa Aditya aluminium smelter in the second half of FY14, though analysts do not expect this to be commissioned even in next financial year. However, the 58-ktpa Hirakud aluminium expansion, 135-ktpa flat rolled products project and the 20-ktpa foil project are in the process of being commissioned.

These capacity additions come at a time when aluminium prices have softened and the outlook remains weak. The aluminium prices on the London Metals Exchange (LME) that hovered above $2000 a tonne levels till February 2013, have now slumped to $1800-$1900 a tonne levels. Analysts peg average aluminium prices at around $2000 a tonne during FY14.

Key concerns

Since the coal block at Mahan is not mining-ready, the captive power plant will not be of much use for Hindalco, thereby impacting the overall profitability. For Mahan smelter though, the company feels the cost of production will be $1800 a tonne, analysts do not see the same in absence of captive coal.

Giriraj Daga at Nirmal Bang suggests that the smelter will not be viable if aluminium prices remain below $ 2200 a ton. Bhavesh Chauhan at Angel Broking suggests that without captive coal block, the Mahan smelter is expected to face cost pressures, resulting in lower return ratios over the next two years.

The concerns on profitability are further aggravated as Hindalco will have to service the debt despite low cash flows. The depreciation cost will also go up, thereby impacting the bottom-line further. Majority of Hindalco’s capex had been allocated to greenfield projects – Mahan aluminium, Utkal and Aditya.

Though the net debt-to-equity for the company stands at 1.16x, Ashish Kejriwal, an analyst at Elara Capital says that this is expected to increase further in FY14. Net debt/EBITDA continues to remain high at 5.3x, he adds. Interest/PBIT for the consolidated entity, on the other hand, is expected to move up from 35% in FY13 to 49% in FY14.

International operations

The company’s international subsidiary – Novelis – is also likely to feel margin pressure in FY14. Analysts at Espirito Santo observe that Novelis gave flat to lower EBITDA guidance for FY14, despite having commissioned new facilities, indicating pressure on margins.

As per its 10K filings, new contracts in North America were signed at lower conversion premiums indicating pricing pressure in the region.

Hence it is not surprising that the FY14 consolidated profits are expected to dip by almost 10-30% as per various analyst estimates before rebounding in FY15. Given this, the stock may trend downwards till market starts factoring FY15 estimates.

The long-term investors, however, can use the opportunity to accumulate the stock as one-year target price as per Bloomberg data stands at Rs 115.21.