 "Phil Martens")
Phil Martens, the president and chief executive of Novelis, the world's leading producer of flat rolled aluminium products, is agitated. That's because the US subsidiary of Kumar Mangalam Birla-owned Hindalco Industries is facing multiple issues that are diluting the expected returns from the investments of over $2 billion the company has made in the last four years. The latest addition to his woes came on March 27 when a United Kingdom court ruled against the implementation of a new London Metal Exchange, or LME, warehouse rule that was aimed to reduce aluminium inventory build-up. This goes against Novelis which is a converter: it buys primary aluminum from the market and produces high-value flat products. It will have to now procure aluminium in the US and European Union at higher rates.
"It is indefensible that queues of more than a year exist at warehouses and unconscionable that players in the aluminum market are actively working to maintain the status quo to protect artificially inflated premiums," Martens said in a statement. "The divergence between the LME price and the market price is undermining the credibility of the industry's price discovery process and is causing havoc at the fabricating and consuming end of the industry."
This twist comes when Novelis is in the midst of a serious expansion drive to cope with the emerging market trends. This is perhaps the real reason for Martens' angst. The company, which was acquired by Hindalco for $6 billion in 2007, counts marquee names such as BMW, Audi and Coca-Cola amongst its customers. Its operations are spread in 9 countries across four continents: North America, Europe, Asia and South America. It shipped 2.8 million tonnes of flat products in 2012-13. Of this, the highest - 62 per cent - went to make beverage cans, while 6 per cent was sold to the automotive industry. Out of the rest, 20 per cent was used for foil and 12 per cent for specialties such as architecture and electronics.
But this is set to change over the next few years. The demand from the automotive sector is expected to grow 30 per cent annually till 2020 as globally regulations are driving a shift toward more fuel-efficient cars which, in turn, is leading to more use of aluminium, especially in the engine. In contrast, the beverage cans industry is expected to grow at mere 4-5 per cent annually. For specialty products also, the growth is expected to be around 6 per cent annually till 2020.
Anticipating this change, Novelis went into investment mode to expand its recycling and rolling facilities. The company wants to reach 80 per cent recycled metal input across its products by 2020, up from 43 per cent in 2012-13 to get the cost benefit. Thus, in the quarter ended December 31, the company commissioned three very large investments: a new cold-rolling mill in Brazil, and two expansions in South Korea (a cold-rolling mill at Yeongju and a hot-rolling mill at Ulsan). It added a combined 570 kilo tonnes of rolling capacity. (The company has another $500-million investment plan for 2014-15.)
Operationally Novelis reported one of its best 3rd quarter results in recent years: its shipment grew over 11 per cent in the quarter to 780 kilo tonnes. But financially it left the investors worried. The 10 per cent growth in its adjusted EBITDA (earnings before interest tax depreciation and amortisation) to $203 million fell short of its estimate of $214 million. This was largely attributed to a 3 per cent decline in premium from the previous quarter to $1,291. In February, Martens said in an investor call: "There are (a) few market pressures that are currently affecting the aluminum flat rolled products industry." The key one is the idle capacity in both aluminum can production and can sheet production across Asia.
China's GDP growth in 2013 was less than 8 per cent, the lowest in a decade and far lower than originally forecast. This has resulted in overcapacity in the region and is driving competitive activity across the industry. It also has created a lower price environment. This has forced Novelis to reduce prices to remain competitive, and this is what caused the dent on its earnings for the December-ended quarter. "We expect these regional pressures and a slower-than-expected growth in the Chinese economy to continue to negatively impact our business through the next year," Martens said.
In North America too, there is a softening of demand for beverage cans. As consumer preference shifts towards healthier alternatives, the outlook for carbonated soft drinks is weak. The company estimates that the can sheet market in North America will continue its downward trend with a decline between 2 per cent and 4 per cent this year. Lower consumer demand has resulted in overcapacity in the market and created unfavourable pricing dynamics for suppliers like Novelis. Because of these pressures, the average aluminum price in the December-ended quarter was 12 per cent below last year's levels. But there hasn't been a corresponding fall in scrap prices. As a result, scrap spreads have tightened and the benefit that the company gets from using recycled inputs has lessened. Going forward, as the company shifts hot mill capacity in North America from beverage cans to the automotive sector, it is expected to balance the demand-supply scenario.
"The strategy we set in motion several years ago to grow our portfolio of premium products, to increase the recycled content in our products and our disciplined approach to capturing growth through expansions will allow us to navigate through these headwinds and emerge a strong company when we complete," Martens reiterated. But that did not satisfy international credit rating agency Moody's which put Novelis' corporate family rating B1 under lens as B1-PD, implying probability of default. The company had net debt of $4.6 billion at the end of 2012-13. Its debt figure for 2013-14 is not available as the results are due next month.
"The review for downgrade results from the continued weak performance of Novelis which has resulted in a deterioration of debt protection metrics," says Carol Cowan, vice-president - senior credit officer, Moody's Investors Services. The rating agency cited evidence of contraction in the EBIT/ interest ratio to 1.7 for the 12 months ended December 2013 and an increasing leverage position as evidenced by the debt-EBITDA ratio worsening to 6.9 for the 12-month period from 5.6 for the year ended March 2013.
Moody's view has been slammed by the Aditya Birla Group. "S&P has rated Novelis 'stable' at B+; we do not agree with their assessment," a top official from the group who does not wish to be identified says. Another group executive had told Business Standard that Moody's had come to the conclusion by analysing only three months' data, whereas a fair assessment required a longer-term view.
