Alcoa, Novelis numbers suggest worst over for aluminium firms

Improvement in profitability expected despite fears of increased Chinese supplies

The strong operating performance by Hindalco’s US subsidiary Novelis, within a few days of an impressive show by New York-based aluminium maker Alcoa Inc, instigates confidence that worst may be over for the aluminium sector. While Alcoa gained from higher demand and prices of aluminium, Novelis, which is mainly a converter of primary aluminium into value-added products, benefited from higher demand (lower premium over benchmark aluminium prices though benefited Novelis).

Extreme pessimism had led to aluminium prices falling to lows of $1,450 a tonne on the London Metal Exchange (LME) in January. The prices, however, have recovered thereafter to over $1,600 a tonne, making aluminium the third-best performing base metal (behind zinc and nickel) on the LME so far this year. While there are risks over increased supply from China putting pressure on prices, analysts have been increasing their price estimates regularly. For instance, analysts at HSBC have recently increased their aluminium price forecast for 2017-18 by three per cent, led by the resilience in the market.

Added to improved price forecast is the expectation of increase in demand from certain segments. The encouraging commentary by Alcoa management, indicating strong uptick in demand from automotive segments and better realisations, is heartening.

Companies like Novelis have been adjusting their product mix in line with demand, leading to improvement in profitability. Novelis walked out of some low-margin ‘can’ contracts. Though it may have affected its volumes (which fell 1.7 per cent year-on-year in June quarter), its Ebitda per tonne of $355 was much better than $277 in the same period last year. Analysts at Kotak Institutional Equities attribute the 26 per cent year-on-year increase in Novelis’ adjusted EBITDA (excluding metal price lag and one-off items) to automobile segment. They add that growth will be driven by higher automotive shipments.

Analysts at Motilal Oswal Securities believe that Novelis’ Ebitda will continue to improve, rising to $358 in FY18 from $309 in FY16, led by improving product mix and cost efficiency at new plants.

Meanwhile, Novelis’ stellar performance in June quarter lifted Street sentiments, pushing up Hindalco’s stock to 52-week high of Rs 151.90 on Monday.

Analysts will now be watching for Hindalco’s domestic performance (due on Friday), which will play a key role in any revision of analysts’ estimates and target price. Besides profitability, analysts will also be looking at the trend in free cash flows, which is necessary for faster deleveraging of the company’s balance sheet.