Slowing demand, higher valuation point to weak outlook for Hindalco

The supply-demand equation in aluminium continues to look confused but it may be net-negative for producers. The global slowdown is clearly reducing demand for the metal across the automobile, aviation and beverages industries. However, supply is also being cut.

Weak downstream demand will have a negative impact on Hindalco’s US-based subsidiary, Novelis. North American can-maker, Ball Corp, which is Novelis’ largest customer, has cut its own volume growth estimates across North and South America, citing high inflation as a major cause of demand destruction.

While Ball has lowered its five-year growth estimates to the lower end of its earlier prediction, it has also cautioned that near-term demand destruction in 2022-23 could be greater, with some recovery in the mid-term. Novelis derives 60 per cent of its sales from the can industry and given that Ball is the largest customer, this will inevitably impact the company. Moreover, other valued-added downstream consumers like Arconic also have guidance indicating lower growth. This is not an isolated phenomenon. Novelis also has ongoing capex plans, which will impede free cash-flow.

Lockdowns in China, energy shortages in Europe and tightening interest rates may have an impact on production, leading to lower supply. But demand could fall even faster, given slowdowns. Global aluminium prices rallied 40 per cent between January and March 2022 but they have since fallen nearly 50 per cent. September spot contracts are trading 20 per cent below their June levels.

At the same time, rising energy costs are forcing up production costs everywhere. Smelters in Europe and in China have shut down, which means supply is constricted. Hindalco’s guidance indicates that manufacturing costs have risen and the company is expecting further cost rise in Q2 for or July-September quarter for the 2022-23 financial year (Q2FY23) due to high coal prices. Winter heating demands in Europe and America will maintain upwards pressures on coal prices, given gas shortages due to the Ukraine war. The earnings before interest, tax, depreciation and amortization (ebitda) per tonne for aluminium (blended for different categories) could fall by 40 per cent in the second half of FY23.  

Hindalco is better-placed than most non-ferrous metals producers because it has access to high-quality bauxite from its own mines and has its own captive power capacity. It is also well-placed to take advantage of any downstream value-added demand via Novelis. Hindalco also has exposure to copper but that has also seen price-collapse.

If the metals cycle is trending lower, and it seems that way, Hindalco will see margins squeezed, though it is ahead of its competitors. Other non-ferrous metals producers like Vedanta and the government-owned Nalco (National Aluminium Company) will also see similar or greater margin pressure. Hindalco has been deleveraging through the last two fiscals and has a good balance sheet but it is a cyclical like any other commodity player.

The share price of Hindalco is down 23 per cent in the last 12 months and down 13 per cent in the last month. That is an underperformance against the Nifty50 (down 4.5 per cent in 12 months and down 3 per cent in a month). Historically, Hindalco has tended to hit its lowest cyclical valuation at around 0.3-0.5x price to book value (P/BV) and it’s trading at around 0.9x P/BV now (FY23 estimates). While analysts are suggesting a ‘hold’, there may be a downside.