Pricey metal

Though metal prices have risen and Hindalco’s financials are improving, its stock valuations already reflect most of the positives.

The LME aluminium prices, which made a low of about $1,250 per tonne in February this year, have since recovered by about 48 per cent. This is also a reason that companies like Hindalco Industries, which is a leading aluminium player in India, have seen its share prices bounce back.

During this period, its share price has run up by almost 230 per cent from its lows. But, besides recovery in metal prices, the company's plans to raise funds as well as improving profitability of its US subsidiary, Novelis, has contributed partially to run up in its share price.

However, analysts believe that most of the positives are already factored in and valuations have become expensive. Besides, they highlight the risk on account of the high debt in the company’s books and a possible equity dilution on account of its fund raising plans.   

The edge
Hindalco Industries is leading player in the aluminium and copper space. Its integrated operations give it an edge resulting in lower cost of production as compared to some of the companies in the sector. However,

given that aluminium accounts for 74 per cent of its revenues, the lower international aluminium prices have resulted in a decline in revenues and profits for the company recently.
 

GAINING STRENGTH
in Rs crore	FY09	FY10E	FY11E
Sales	65,415	52,850	56,593
EBITDA	3,665.0	5,123.0	6,128.0
Net profit	485.0	1,152.0	1,559.0
RoE (%)	1.8	5.9	7.8
EPS (Rs)	2.6	6.5	9.1
Book-value per share (Rs)	93.2	107.8	112.0
PE (x)	49.2	19.8	14.2
P/BV (x)	1.4	1.2	1.2
E: Analysts estimates

During Q1 2009-10, the company reported a 16 per cent year-on-year (y-o-y) decline in standalone revenues at Rs 3,899 crore, which was primarily on account of the 40-50 per cent lower international aluminium and copper prices. However, despite this the company was able to report relatively better margins given that it is among the low-cost producers of aluminium globally.

For Hindalco, the average cost of producing aluminium is about $1,400 per tonne, whereas the metal is currently trading at about $1,850 per tonne. Also, as the company generates about 54 per cent of its revenues from value added products, which enjoy relatively higher margins, it helped through better realisations.

Global operations improving?
In the aluminium business, the company has exposure to some of the overseas markets through its US subsidiary, Novelis. Novelis produces aluminium sheet and foil products for customers in high-value segments including automotive, transportation, packaging, construction and printing industries.

During the recent past, Novelis’ performance suffered due to lower metal prices at LME (London Metal Exchange) coupled with severe demand destruction in two of its major markets, the US and Europe. This had a toll on Hindalco’s consolidated performance, given than Novelis accounts for over 70 per cent of the consolidated revenues.

In 2008-09, Hindalco reported a profit of Rs 2,230 crore on standalone basis, but the same was down to Rs 485 crore on the consolidated basis due to losses at Novelis.

This year, as things are now expected to improve, analysts believe that while there may not be much gain on account of volumes for Novelis, but as the EBDITA per tonne has improved from low a of $83 per tonne in Q4 2008-09 to about $180 per tonne, the company should be in a better position.

The improvement in the EBDITA is on account of cost cutting, closing down of some of capacities and better product mix.

On a consolidated basis, the aluminium business might see improvement in volumes given the commissioning of new capacities in India and marginal improvement in Novelis’ volumes in the recent past. But, since LME aluminium prices are still low as compared to last year, realisations could be lower compared.

Stable outlook
In the copper business, which accounts for the remaining 26 per cent of revenues, analysts expect volumes to sustain at last year’s on the back of lower demand. Additionally, realisations could remain muted since TC/RC margins (conversion margin) are lower this year due to lower LME copper prices as well as demand.

The TC/RC margins have dropped significantly from about 18c/lb in January 2009 to about 10c/lb in July 2009.

Analysts also says that despite a 32 per cent increase in production in Q1 2009-10, the copper segment reported sales of Rs 2,480 crore, which was lower by 8 per cent y-o-y, which is primarily due to the near 50 per cent fall in LME copper prices.

Overall, sequentially the outlook is better for both the segments, namely aluminium and copper, due to marginally higher volumes and recovery in metal prices. This year, the company's consolidated turnover is expected to be in the range of about Rs 52,000-53,000 crore, which is 19-20 per cent lower compared to last year.

However, despite lower expectations of revenue, the consolidated operating profits could be higher by about 40 per cent at Rs 5,122 crore while net profit could jump by about 140 per cent in 2009-10. The strong growth in profitability is mainly due to the increased contribution from Novelis in the form of higher EBIDTA per tonne and marginal increase in volumes.   

Conclusion
Although fundamentals are seen improving in the near term, but for the share prices to command current valuations analysts believe that LME metal prices should improve further.

Analysts estimate that while LME metal prices have recovered from their lows, they may not rise further in the immediate future considering the weaker global demand. Besides, analysts are also concerned about the company’s high debt-equity of 1.4 times and consolidated debt of $4.5 billion.

Although to tackle the situation, the company is mopping up funds to the tune of $500 million by way of a GDR and QIP offering, part of these funds are expected to be used to fund its capacity expansion plans, which will take its present aluminium capacity to treble by 2013.

"The fresh funds will not only bring equity dilution, but also increase interest cost in case the company further leverages its balance sheet to part fund its huge expansion plans in India," says Rakesh Arora, who tracks the metals sector at Macquarie Securities.

More importantly, at Rs 129, the stock factors in most of the gains accruing on account of the recent rally in the global metal prices as well as improvements expected in Novelis’ fundamentals.

At the current price, there is no room for appreciation given that the stock is trading at 20 times its 2009-10 and 14.2 times its 2010-11 estimated earnings.