At current prices, the Hindalco stock offers once-in-a-generation opportunity, feels Mudar Patherya.
Recommending a stock at a time like this is like facing Glenn McGrath without an abdomen guard. But, sometimes it becomes more important to stand up for what one thinks is right and to hell with telephone calls to my missus asking if I have lost it. Ignore the puns at a time like this.
Perhaps no stock in the last fortnight has provoked the good old mardaangi (again, non-chauvinistically) more than Hindalco. A quick backgrounder: the company acquired Novelis, one of the world’s largest downstream aluminium processors in 2007, mobilised debt in a special purpose vehicle to fund the acquisition, proposed a significant (3:7 at Rs 96 a share) rights issue to correct its gearing, struggled in mobilising the proceeds as its stock declined below offer price, the word spread on the markets that the good old aluminium uncle would now need to empty the pockets and count the loose change as its stock declined to a market capitalisation of Rs 7,000 crore.
Why would one stake one’s reputation out on Hindalco at a time like this? Why counter the general fear that consumerist India will count all paise, capex files marked ‘2010-11’ will returned to the steno for cabinet-filling, and cash will be neatly layered in bank lockers? This is why.
* When you see a stock like Hindalco at a price of Rs 40-60 and a market capitalisation of Rs 7,000-Rs 10,000 crore, it is not just another opportunity; it is a once-in-a-generation opportunity, especially when you factor in a per share book value in excess of Rs 140.
* When you buy a stock like Hindalco at a market capitalisation of Rs 10,000 crore (last week’s closing), we are valuing the country’s entire primary aluminium sector at a market capitalisation of only Rs 25,000 crore (because Hindalco accounts for 42 per cent of the country’s market share) and dismissing the value of all the remaining value-added parts (rolled products, extrusions, foils and wheels) for free.
So, here is my two-paise bit: Hindalco can call off its Rs 30,000 crore expansion-cum-modernisation plans and prefer to buy out the rest of the Indian manufacturers - for less!
* When you buy a stock like Hindalco, you don’t only buy earnings; you also buy embedded value not immediately evident. For here is a company with an investment book plus cash-bank balance of Rs 14,255 crore (as on 31 March 2008) quote at a discount of Rs 4,000 crore.
So, when you go long on the stock it is the equivalent of the retailer telling you bhaisaab ek minute, reaching below the shelf and fishing out the aluminium-copper story, then fishing out bauxite mines, then giving you sound management, then Kumar Mangalam Birla and finally some cash. Aapko Hindalco khareedne ke liye paise nahin dena padega; again aap khareedenge to main aapko paisa doonga, he says!
* When you buy a stock like Hindalco, you are effectively buying the world’s largest aluminium rolling company with 3.1 million MT capacity (through Novelis), a combined turnover of $ 13-14 billion and a presence in 11 countries.
* When you buy a stock like Hindalco, you are buying an integrated strategy of the primary production capacity (alumina and metal) being enhanced out of India balanced with the value-added downstream product capacity of Novelis across the world, a neat fit over companies focusing on only one part of the game.
* When you buy a stock like Hindalco (standalone) for a mere Rs 10,000 crore, you buy a company with an installed alumina capacity of 1.5 million TPA, metal capacity of 0.48 million TPA, secondary aluminium capacity of 25,000 TPA and 1,187 MW – at a replacement cost of Rs 50,000-60,000 crore at today’s capex yardstick.
* When you buy a stock like Hindalco, you buy relative industry protection because, while the business is free for people to enter and exit at will, it is relatively protected on account of a high capital commitment – $3,000 per tonne for primary metal and $1,000 per tonne for alumina - and the extended gestation required to break even. And more bankers are likely to give Hindalco cash for expansion in today’s investment climate than a new guy .
* When you buy a stock like Hindalco, you don’t just buy existing volumes, you buy projected volume growth. The company is engaged in enhancing its alumina production capacity from 1.5 million TPA to 4.5 million TPA and primary aluminium capacity from 0.5 million MT to 1.6 million (which is the equivalent of saying that the company expects to achieve three times of what it has done in the last five decades in only the next four years).
* When you buy a stock like Hindalco and all its projected growth, you are probably doing so without gearing its straining because the company is funding its capex in excess of Rs 30,000 crore through a mix of rights (concluded), preferential allotment, cash flow and a relatively low proportion of debt that could potentially reduce its total debt from around Rs 32,000 crore to Rs 23,000 crore and reinforce net worth from Rs 19,000 crore to Rs 26,000 crore. That’s a company with an enterprise value of around Rs 50,000 crore available for a fifth of the valuation.
* When you buy a stock like Hindalco, you are inevitably putting your money on one of the lowest cost primary aluminium manufacturers in the world (around $1,300 a tonne at today’s exchange rate). Sure, you can forecast LME per tonne prices down to $2,000 or below. but remember that when this happens most manufacturers may haemorrhage their way to Form-11, while Hindalco may still be comfortably solvent.
* When you buy a stock like Hindalco, you are buying into a proxy of higher production starting from this year, declining cost of production, increasing captive power generation, strengthening product mix and a weakening rupee – and all this is within the company’s control except for the last reality, a fair de-risking.
* When you buy a stock like Hindalco, it might be safe to assume the worst – the rupee strengthening to Rs 41 to a dollar and LME declining to $1,900. At that level, a back of the envelope scribble indicates an EPS of Rs 5 or a cash flow of around Rs 1,500 crore. The flip argument: inflation will have declined, FDI inflow would have rebounded and what one would have lost out in terms of earnings in Hindalco, one could well have recovered through an increase in discounting.
* When you buy a stock like Hindalco, you are doing so at an interesting divergence – probably its lowest discounting on the one hand and one of the highest earnings in any quarter on the basis of results announced for the second quarter of 2008-09. The company reported an EBDT of Rs 1,085 crore in the July-September quarter as against Rs 1,088 crore a quarter earlier.
* When you buy a stock like Hindalco, you could be potentially bracing for the fact that in the next two quarters the company will earn only half of what it reported in the first six months of this year (my assumption), equity increases to Rs 175 crore and there is no immediate net cash benefit of the rights inflow.
So, my earnings estimate of Rs 2,100 crore post-tax for 2008-09 is a come-down on the Rs 2,860 crore post-tax profits reported in 2007-08 but even at this level, it is a relatively conservative discounting of 5.0 with adequate volume ammunition being built into the system that will progressively play out in the next three years.
* When you see a stock like Hindalco being reduced to a psychotic valuation, the inference is that some undiscovered invention will replace aluminium, the power industry (large consumer) will cease to expand, vehicles will stop rolling, people will stop being thirsty and a company that survived some 50 years will go bust in three.
So, no aluminium conductors, no aluminium vehicle body or components, no beverage cans. This is not merely a consumerist call; it is a civilisational call, because while it will indeed be possible to live without aluminium and Hindalco, we will all just have to buy, among other things, thousands and thousands of candles.
Mudar can be reached at mudar@trisyscom.com. He bought some Hindalco stock for his children on Friday last
