Risk-reward, Aleris' acquisition turning favourable for Hindalco Industries

Apart from strong performance by Aleris and a tight auto sheet market in US, analysts say aluminium prices are also bottoming

Hindalco

Shares of Hindalco have rebounded about 8 per cent from its lows in mid-February this year. A strong December quarter performance reported recently by Aleris and an equally healthy future outlook indicates the acquisition of Aleris will be value-accretive for Hindalco. 

Hindalco had announced the acquisition of Aleris in July last year, and completion of the same is expected soon. Further, the acquisition also reduces some concerns on the performance of Hindalco’s international business. Moreover, the worries over volatility in base metal prices, rising imports in the country, too, are getting addresses, say analysts, who also feel that global aluminium prices, which are down 25 per cent since April last year, may be bottoming out. 

All this indicates that the risk-reward may be turning favourable for Hindalco, which is still down about 20 per cent on the bourses in the last one year.

Gains in US business

Aleris’ December quarter operating profit growth of 64 per cent was ahead of estimates and driven by shipments in the auto and aerospace segments in North America, Europe, and Asia Pacific. This bodes well for sentiment, as a slowdown in auto, a profitable segment especially for Novelis (Hindalco’s US subsidiary), was seen as a concern. Analysts say they expect Aleris to benefit from ramp-up of automotive body sheets capacity at Lewisport, Kentucky (US) and a favourable aerospace demand cycle. 

“The calendar year (CY18) performance reaffirms the belief that $360 million in earnings before interest, tax, depreciation and amortisation by 2020-21 is achievable (30 per cent higher than CY18 levels), driven by profitable automotive and aerospace segments,” say analysts at Edelweiss Securities. 

The analysts also feel that the acquisition Aleris will be value-accretive for Hindalco, India’s largest aluminium maker.

What’s more, Aleris will also help improve Hindalco’s product mix. Currently, the share of cans, a relatively less profitable segment, in the overall portfolio of Hindalco is 61 per cent and the same would drop to 47 per cent following the acquisition of Aleris, point out analysts. Further, the beverage can markets are also improving and despite auto sector headwinds, aluminium sheet demand has been resilient due to rising aluminium sheet intensity. 

“There are concerns around downward re-pricing of contracts, but we think meaningful re-pricing is unlikely in the near term as US aluminium auto sheet markets are still tight,” say analysts at Jefferies.

Improving outlook

Even as the Street will be watching for the renewal of auto contracts, there are signs that global aluminium prices may improving. Aluminium prices had corrected significantly by more than a fourth, compared from $2,540 a tonne levels at the start of 2018 on the London Metal Exchange (LME). 

The trade war concerns and soft demand from China have led to the correction. However, the per tonne aluminium price on the LME, after seeing sub-$1,800 levels in January 2019, is inching towards the $1,900 mark. The LME aluminium has still underperformed copper and zinc, which are up 7-8 per cent and 13 per cent, respectively, in CY2019 to date. 

Analysts say the lifting of Rusal sanctions, weak Chinese downstream demand, rising Chinese aluminium exports, and falling cost curve (lower alumina cost) have weighed on aluminium prices in CY19 too. Nevertheless, analysts at Jefferies say they believe aluminium prices on the LME are bottoming out and may recover as smelter spreads are still thin, alumina prices are stabilising, and Chinese downstream demand may improve. 

Further, analysts also say that curtailment of 3.8 million tonnes capacity (9 per cent of global capacity) in China and uncertainty around resumption of full production from Alunorte, a large producer of aluminium based in Brazil, are expected to aid integrated aluminium players.