How Hindalco ringfenced itself from uncertainty with value-added products

There was a time when nearly 75% smelters in the world were not able to recover production costs from aluminium sales

How does a producer de-risk the commodity business that is aluminium? Smelters making primary aluminium are exposed to major price fluctuations on the London Metal Exchange (LME). Since July 2008, when the silvery white metal traded at a high of $3,075 a tonne, it has remained on a roller coaster with three month LME prices moving between a low of $1,300 a tonne in the wake of global economic crisis and the present around $2,000 a tonne. In fact, there was a time when nearly 75 per cent smelters in the world were not able to recover production costs from aluminium sales. 

His belief that the only way to ring fence an aluminium group from LME price fluctuation is by way of graduating to making big volume value added products (VAP) out of the metal led Kumar Mangalam Birla, chairman of Hindalco Industries, to buy the US-based Novelis, a world leader in VAP and scrap recycling, in a nearly $6 billion all-cash transaction in February 2007. At that point, Birla had to contend with quite a few naysayers both within and outside the company. In the years since its takeover, Novelis has grown in strength by focussing on automotive products, other speciality applications and metal recycling and at the same time closing down some loss making units. 

In any case, aluminium VAPs are found to be resilient enough to weather out LME price fluctuations. But making VAPs, especially at the upper end such as for aerospace and increasingly demanding automotive applications, require technologies which are available with a handful of companies in the world. Birla knows it well that it is only by way of acquisition, Hindalco could secure global leadership in VAPs. 

It will be in order to look at the 2017-18 working of 100 per cent Hindalco subsidiary Novelis, which, subject to regulatory approvals of the US and some other countries, is to acquire the US Aleris Corporation at an enterprise value of $2.58 billion. In a record performance, Novelis saw its profit after tax in 2017-18 sprinting to $635 million, from $45 million in 2016-17, with never before free cash flow of $406 million. Rapid rise in auto products deliveries, which had a 20 per cent share of the 3.2 million tonnes (mt) of all VAP shipments in 2017-18, recycled material constituting an elevated 57 per cent of all aluminium inputs and the US subsidiary unlocking value amounting to $314 million by selling 50 per cent ownership of its South Korean Ulsan facility dedicated to automotive and specialty sheet to Kobe Steel of Japan underpinned Novelis' outstanding performance. Novelis is, therefore, well primed for a major acquisition.

Aleris is an asset rightly coveted, for it will give the acquirer access to “marquee” high-end aluminium aerospace application, further reinforce its presence in the automotive sector in the US, Asia and Europe and secure “a great customer franchise.” As it would happen, Novelis’ move coincides with Aleris’ completing investment of $900m, including $350m in aerospace facility, in Zhenjiang in China and the balance in auto body sheet segment in the US and Europe. Equally importantly, the acquisition opens the door for Hindalco’s India-based VAP operations to embrace the world class Aleris manufacturing system and practices.

Hindalco Managing Director Satish Pai has said Aleris with aluminium aerospace application will prove useful for the Indian company to make products for the defence sector.  

Hindalco, which enjoys leadership status in VAP segment of the aluminium industry in India, is targeting doubling of value added production here in the next five years. No doubt, in its endeavour to convert larger and larger quantities of its own primary metal into flat rolled products and extrusions, Hindalco will make use of Aleris technology to mark up its presence in building and construction and transport segments. The multi-location Hindalco produced 1.3 mt of aluminium and 2.9 mt of alumina during 2017-18. The company like its peer, National Aluminium Company (Nalco), is among the lowest cost producer of the intermediate chemical alumina, aided by ownership of high quality bauxite deposits. Moreover, the two companies have virtually nil transportation cost as bauxite is sent to alumina refineries from the mines through long distance conveyor belts. 

The fact is Hindalco, in spite of its owning nearly 200 mt of bauxite deposit at Baphlimali hills is not having an exportable surplus of alumina after meeting full requirements of its own smelters. This must be a point of regret in the company since alumina continues to fetch highly lucrative price in the world market. Pai is set to correct the situation in 30 months by adding 500,000 tonne capacity to the 1.5 mt Utkal Alumina refinery at an investment of Rs 13 billion. 

India’s strength lies in refining bauxite into alumina at very low cost of around $160 a tonne. This, however, cannot be said about our smelting of aluminium. The country’s entire smelting operation is based on coal-fired power, which is expensive.  Aluminium producers in the Middle East, Canada and elsewhere using electricity derived from gas and hydel resource, therefore, enjoy cost advantage over Indian smelters. Power alone constitutes between 35 and 40 per cent of the total aluminium production cost. India has an estimated bauxite resource of 3.739 billion tonnes (bt), including proved reserve of 830 mt. Odisha has a share of 53 per cent of national bauxite resource followed by Andhra Pradesh with 16 per cent. Proper exploitation of this rich resource and building of refining capacity in the downstream will enable India to very substantially lift exports from the present around 1.5 mt a year. 

In alumina exports, Nalco Chairman Tapan Kumar Chand has found the moolah. Since he became chairman in July 2015, Chand has focussed on increasing the company’s export of alumina and bringing down the cost of refinery operation. Nalco alumina exports were up from 1.174 mt in 2015-16 to 1.277 mt in 2017-18. It is mainly on the back of low cost alumina exports at extraordinarily high prices that the company's net profit in 2017-18 advanced to Rs 13.42 billion from Rs 6.69 billion in the previous year. 

In the first quarter of the current year, riding on the back of average realisation of $550 a tonne for alumina, Nalco’s profit advanced by a whopping 433 per cent to Rs 6.87 billion from Rs 1.29 billion in the corresponding quarter of 2017-18. Nalco, which enjoys a 10 per cent premium over global alumina prices for its quality, is benefiting from world shortages of the chemical caused by Brazilian production setback.