Hindalco: Dented

A poor show by Novelis and the proposed rights issue will keep the stock subdued.

The Hindalco stock crashed 8 per cent on Monday to Rs 147. This wasn't really surprising because the Rs 60,012 crore aluminium major turned in lower consolidated profits of Rs 2,387 crore for the year to March 2008. That was mainly due to a loss posted by its overseas subsidiary, Novelis.

What's worrying is that India's largest producer of aluminium is looking to dilute its equity through a 1:3 rights issue. It plans to raise around Rs 5,000 crore for repaying the $3 billion (over Rs 12,000 crore) it borrowed to finance the Novelis acquisition in early 2007.

The short-term loans will mature by the end of 2008 and the company, it appears, is not able to find debt at a reasonable cost. Given the state of the equity market, it appears that Hindalco may need to price the rights issue at a fairly large discount to the market price.

Besides, with Novelis having posted a loss in FY08, the Hindalco stock is unlikely to find takers at a price-earnings multiple of more than 10 times forward earnings.

Novelis typically buys aluminium at LME prices and charges clients a premium to convert the non-ferrous metal into higher value products, like cans for carbonated drinks. Sales of products like cans constituted nearly half of Novelis' FY 08 sales of $11.24 billion.

Apart from higher prices of aluminium, a better product mix saw Novelis' per tonne realisations increase by 9 per cent during the year.

However, some of its contracts are fixed price contracts "" these agreements limit the ability of the company to pass on higher aluminium costs to its customers. Last year, the percentage of such sales was just 10 per cent, lower than the 20 per cent levels in the previous year.

As a result, the company's profitability was hit severely. Besides, Novelis faced cost pressures, mainly due to the rising cost of power and fuel, and as a result it posted a pre-tax loss of $62 million. The company competes with fully integrated players that have a better control over costs as well as better pricing power.

That, however, was much lower than the loss of $364 million that it had reported in the previous year. Novelis' exposure to fixed price contracts are anticipated to fall to 8 per cent of its sales for the current year and, therefore, its losses will come down.

Hindalco will find it difficult to leverage Novelis' balance sheet to raise funds. High interest costs, which rose nearly 500 per cent to Rs 1,849 crore, ate into Hindalco's earnings per share in FY08, which fell 41 per cent to just under Rs 16.

The company is expected to end FY 09 with a top line of around Rs 68,000-70,000 crore and a net profit of around Rs 2,000-2,100 crore. However, the earnings will be diluted because of the rights issue. At the current price, the stock appears to be fully valued.