Novelis boost likely for Hindalco

Even as raw material costs remain a concern, a better outlook for Novelis and firm aluminium prices will drive growth

After negative news on coal blocks, bauxite mining, etc, Hindalco’s investors have something to cheer about. The performance, as well as estimates, for US-based Alcoa for the September quarter means Hindalco’s international subsidiary (Novelis) could also post better than expected earnings for the quarter. Also, the demand outlook and aluminium realisations are likely to remain firm. This boosts prospects of Hindalco on the profitability front.

The company has seen concerns on profitability erode about 25 per cent of its stock value since it stood at a 52-week high of Rs 198.70 on July 25.

Though off from recent highs, aluminium prices have continued to improve consistently, owing to closure of some smelters, as base metal prices became unviable. Demand, too, is holding and the demand-supply deficit is expected to remain favourable for realisations.

Aluminium prices, which stood at $1,800 a tonne during the June quarter, improved to $1,988 a tonne in the quarter ended September. While investors remain nervous, as growth has slowed in China (which accounts for the largest chunk of demand) and some smelters have been revived after aluminium prices moved up, the fact that Alcoa has maintained its estimate of seven per cent year-on-year growth in aluminium demand for this year and market deficit of about 0.7 million tonnes (slightly lower than the deficit of 0.9 mt estimated earlier) instils confidence. Analysts at Edelweiss say, “We concur and believe this should boost aluminium prices.”

What’s more encouraging is the gain on the profitability front. Alcoa’s adjusted earnings before interest, tax, depreciation and amortisation (Ebitda), at $1,035 million, was much higher than the expected $882 million, helped by the rolled product division’s improving Ebitda/ tonne of $425, compared with the previous quarter’s $331. Therefore, one might expect a better-than-expected performance from Novelis, too. Analysts at Edelweiss say they have conservatively estimated Ebitda/tonne of $291 for the September quarter, adding this might be exceeded.

Novelis’s profitability is likely to be boosted by a growing share of automobile products. As the company’s auto capacities increase by about 600,000 tonnes, the share of automobiles in its portfolio is targeted to increase to 20 per cent by FY17 (from nine per cent in FY14). The average recycled content in Novelis’s portfolio is projected to increase from 46 per cent in FY14 to 50 per cent in FY15 and 80 per cent by FY20, lowering costs.

  Following mining-related woes, profitability was among the primary concerns of investors. The fact that the Jharkhand government closed five of its bauxite mines in the state came as a dampener, as 35-45 per cent of Hindalco’s captive requirements (domestic operations) were met by the mines impacted, according to estimates. Factoring in the cost differential between captive and imported bauxite, analysts at Espirito Santo had estimated an adverse impact of Rs 7.1 a share on their current fair value of Rs 155 for Hindalco. However, this might be the case only if mining doesn’t restart in the long run, which is unlikely. The company has adequate inventory to meet its requirements for about six months. Also, it can ramp up production from other mines.

The cancellation of coal block allocations by the Supreme Court has also come as a challenge for Hindalco, as profitability of its new capacities depend a lot on the coal blocks de-allocated. The blocks at Talabira-I mine supply 2.5 million tonnes per annum (mtpa) of coal, meeting a third of the company’s domestic requirement. As such, while Hindalco will have to pay Rs 500 crore as penalty for the coal mined from the cancelled mines so far, its Ebitda will be hit due to higher coal costs. Analysts at Motilal Oswal Securities estimate the cost of power generation to increase by Rs 2/kwh on switching to third-party purchase of coal. This will have an impact of Rs 28,000/tonne on the cost of production at Hirakud (160,000-170,000 tonnes), they add.

In such a scenario, the expected gains in Novelis’s profitability and a better aluminium prices outlook bode well, and should offset most of the pressure on the domestic front.

For the quarter ended September, helped by better realisation, Hindalco is expected to record a standalone Ebitda margin of 10.5 per cent, compared with 8.6 per cent in the year-ago period and 9.4 per cent in the previous quarter. Giriraj Daga at Nirmal Bang feels the company’s profit will stand at Rs 1,894 crore, up 15.4 per cent year-on-year year and 17.1 per cent sequentially.

At Rs 166.52, the consensus target price, according to analysts polled by Bloomberg since September, shows an upside of 10 per cent against the current price of Rs 150.4.