Hindalco: Not out of the woods yet

The Hindalco Industries stock declined about two per cent to Rs 110.5 after its December quarter performance failed to cheer the Street. While the domestic operations disappointed on the profitability front with its aluminium products earning lower premium, profitability of its US subsidiary, Novelis, was also impacted due to one-time costs related to enterprise resource planning (ERP) as well as seasonal factors. Global aluminium prices, too, have remained subdued. Copper, however, cushioned the performance and provides a silver-lining for the coming days, too. It contributed 66 per cent to overall domestic revenues and saw improving profitability led by better production and TC/RC (treatment and refining charges) margins.

Going ahead, concerns in the aluminium segment are to weigh on the stock. Giriraj Daga at Nirmal Bang says his assumptions for London Metal Exchange aluminium per tonne prices are at $2,000 and $2,020 for FY13E and FY14E, respectively, and at these prices Hindalco’s new expansion would be value dilutive due to meagre return ratios. According to an analyst at Religare Securities, standalone copper business is expected to do well while aluminium will derive benefits from the new Mahan smelter though higher start-up costs will weigh on profitability in FY14. However, since Novelis is also expected to see some improvement (sequentially) in the March quarter and given the stock’s decline in the last one month, the downside is restricted.

Aluminium: A drag on domestic business
With the temporary disruptions in the first half of FY13 getting resolved, Hindalco’s aluminium production was up 8.6 per cent sequentially. However, on year-on-year (y-o-y) basis, it slumped five per cent to 139,000 tonnes in the December 2012 quarter. The larger disappointment was the 33.4 per cent y-o-y decline in earnings before interest and taxes (Ebit) to Rs 206.4 crore, which was due to lower premium on aluminium products and adverse product mix.

While the cost of production was down three per cent sequentially and is positive, Ashish Kejriwal at Elara Capital says, “We are more worried on the fall in premium as Hindalco is on the verge of commissioning its Mahan smelter whose margins will be squeezed both ways - lower realisation and higher production cost. Thus, the loss could be aggravated further for Mahan.”

Though the Mahan smelter, which is to be commissioned shortly, has a captive coal block (Mahan coal block), which has also got environmental clearances, its development will take time and benefits of captive coal will accrue only in the longer term.

Alumina production too, declined five per cent y-o-y and one per cent sequentially to 326,000 tonnes, primarily due to subdued production at the Belgaum refinery on account of lower bauxite availability. The sourcing of bauxite for the Belgaum refinery remains another area of concern.

The cushion, however, was provided by the copper segment which saw better TC/RC margins. The volumes at 84,000 tonnes also increased eight per cent sequentially. Thus, Ebit of the copper segment grew eight per cent sequentially to Rs 216 crore, giving it a larger share of 52 per cent of domestic Ebit (versus aluminium) compared to 30 per cent in FY12 and 23 per cent in FY11.

Novelis: Impacted by ERP
Novelis is in the process of implementing an ERP in North America, project start-up costs in Brazil and seasonality in Europe impacted performance and saw revenues falling six per cent y-o-y and five per cent sequentially to $2.3 billion in the quarter. Shipments came flat at 647,000 tonnes y-o-y, but were down 10 per cent sequentially (North America was down 14 per cent). Although profitability (Ebitda/tonne) improved in Asia and South America due to better volumes, it was down in North America and Europe due to ERP implementation (related costs of $39 million) and seasonality.

Going ahead, Asian region profitability remains a concern due to competition from China. European region is also witnessing pressure due to subdued demand, particularly from the South European region. However, Novelis has lined up ERP implementation for other facilities thereby covering its entire operations, which will boost profitability, albeit in the long run.

While analyst at Religare expect Novelis’ performance to improve in FY14 (Ebitda estimate of $1.2 billion) with 100,000 tonnes of incremental production, higher scrap benefits and an increasing automotive share in revenues, others like Daga are cautious as they feel it will be a tough period for Novelis.