Headwinds to continue for Hindalco

Though operating performance has seen some improvement, subdued metal prices and demand suggest weak near-term prospects

Hindalco's performance for the June 2013 quarter was satisfactory looking at the improvement in operating profits despite challenges faced by the company. The base metal prices on the London Metal Exchange (LME) were subdued, though some respite to realisations came from rupee depreciation. During the quarter, the company also benefited from lower coal costs, higher copper sales in the domestic market and rationalisation of product mix. Higher other income and dividend also helped in boosting profits that beat the Street expectations by a huge margin.

Nevertheless, despite such performance, the stock closed 2.45 per cent lower at Rs 91.45 on Tuesday. This is because the outlook in the near term remains challenging. The pressure on commodity prices is likely to continue as markets remain nervous on the US Fed tapering its Quantitative Easing. D Bhattacharya, managing director, Hindalco and vice-chairman at Novelis observed, "Macro headwinds are likely to continue although further downside risk to LME could be less".

Hindalco, which is a low-cost aluminium producer, is commissioning cost-effective manufacturing facilities. However, the benefits of the same will take some time to accrue till the facilities stabilise and the captive coal blocks start supplies. Further, Novelis (Hindalco's US subsidiary) is also facing pressure and analysts do not expect much improvement before FY15. In the backdrop, the Street does not see any substantial improvement in Hindalco's financials and expect the stock to continue trading weak. Analysts remain divided though. According to Bloomberg (prior to results), 20 analysts had a Buy rating, 14 Hold ratings and 16 Sell ratings on the stock, with a consensus one-year target price of Rs 119.

Q1 profits beat estimates
Hindalco's net sales at Rs 5,898 crore came lower than Street expectation of Rs 6,032 crore. However, on operating front some benefits accrued due to lower coal costs, while larger gains came from rationalisation of product mix, thereby boosting Ebitda and margins (8.19 per cent compared to 7.63 per cent in June 2012 quarter). Net profit got further boost from rise in other incomes (Rs 225 crore up 31.5 per cent year-on-year) and dividend from subsidiary (Rs 203 crore up 56 per cent year-on-year). Hence, net profit at Rs 475 crore improved 11.5 per cent year-on-year and came much ahead of expectation of Rs 322 crore.

Weak metal prices hurt
Even as weak rupee helped, weak base metal prices put pressure on sales. Average LME aluminium prices during June quarter at $1,847 a tonne were lower by eight per cent sequentially and seven per cent year-on-year, while average copper prices at $7,201 were down nine per cent sequentially and eight per cent year-on-year.

In terms of output, the company produced higher aluminium and alumina, pushing up sales from the segment to some extent. The copper cathode rod (CCR) production at 68,000 tonnes was marginally lower than 69,000 tonnes in the year ago quarter. However, value-added CCR production was higher at 41,000 tonnes compared to 36,000 tonnes in the year-ago quarter. Most of its produce (85 per cent) was sold in India, which helped improve profitability. The copper segment that contributed 62 per cent to revenues saw an eight per cent decline in profits due to lower copper prices that led the fall in net sales despite rising aluminium sales.

Capacity expansion
The company has started first phase of 1.5 million tonnes per annum (mtpa) Utkal refinery and Mahan smelter in June 2013 quarter, while plant commissioning of Aditya smelter is expected in H2FY14. The projects will take some time to stabilise though. The company that is likely to get Stage 2 clearance of the Mahan coal block soon could see production start by end of 2014. Thus, even as volume gains from these expansions may start accruing, gains on the profitability front will be optimal only by end-2014.

Novelis has also begun commissioning of its South Korea expansion (350,000 tonnes per annum) and North American automotive finishing line (240,000 tonnes) is on track to be commissioned in the September 2013 quarter. Nevertheless, the expansions have led to the debt increasing; long-term debt-equity ratio of this subsidiary, thus, stands at 4.8. The shipments of Novelis in the June 2013 quarter stood at 708,000 tonnes while Ebitda at $204 million declined 21 per cent year-on-year. Hindalco's CFO, Praveen Maheshwari, says the debt should reduce as Ebitda improves. However, analysts are not so optimistic.