Near term challenges for Hindalco

Novelis, Hindalco's US subsidiary, which is a producer of value-added aluminium products, reported a weak performance for the quarter ending March 2015. The stress on profitability was evident given that EBIDTA per tonne at around $265 was 20 per cent lower than seen in March 2014 quarter and 15 per cent lower sequentially.

The inability to pass on costs of earlier aluminium metal purchases that Novelis bought at higher regional premiums impacted the company's performance and is likely to cause stress in the coming few quarters as well, believe analysts. While the decline in aluminium premiums (additional price over and above the benchmark rate), especially in Asia, can benefit in the longer run enabling Novelis to produce at competitive prices compared to Chinese players, in the near term it will remain a drag on the company's profitability.

The macro headwinds in terms of demand and adverse currency movement, too, have hurt the profitability of US business. Though weak demand in the cans business could have been offset to an extent by increasing high margin portfolio for automotive sales, the gains were offset by a depreciating Euro, declining regional premiums and hot mill outage in North America (a one-off) in Q4FY15, say analysts at Elara Capital.

The volatility in aluminium prices and realisations due to weak demand across geographies and especially from China has been a concern for aluminium producers. While Novelis has been working on capacities that have increased to 3.6 million tonnes per annum (MTPA), it has also worked on increasing automotive sales that increased from 5 per cent to 11 per cent of revenues in FY15. Besides, re-cycled material (helps lower costs) has also increased to 49 per cent in FY15 from 33 per cent in FY10. But despite these moves, profitability has still remained lumpy. A few quarters back, the company was seeing profitability increase due to rising aluminium premiums, but falling premiums have hurt profitability. Analysts at Elara Capital say that EBITDA has actually contracted at a CAGR of 4 per cent (over a five year period) to $902 million in FY15.

The aluminium prices, too, have been showing weakness of late. The weekly metals report of Motilal Oswal Securities (dated 18th May) shows LME aluminium was down 3 per cent over previous week to $1,813/tonne, following a similar decline last week. Global aluminium production in February 2015 grew at its strongest pace since last many months, up 20 per cent year-on-year while December-February 2015 average growth came in at 12 per cent.

For the quarter ending March 2015, average aluminium prices on the LME at $2,124 a tonne are down seven per cent sequentially and 10 per cent year-on-year. The outlook for FY16 and FY17 also remains benign with analyst at Motilal Oswal Securities cutting their average aluminium price estimates by $50 a tonne each to $1,900 for FY16 and $1,950 for FY17. Hindalco being a primary producer of aluminium benefits from higher prices and premiums.

Thus, with challenges in aluminium prices and premiums, Hindalco stock has corrected from highs of Rs 198.70 in July 2014 to Rs 139 levels now-it is down from Rs 158 levels in early March 2015.

There are some positives though. The company is ramping up production in India too and will benefit from increasing volumes. Secondly, it has also been able to get coal blocks to meet 65 per cent requirement of its Mahan and Aditya smelter, thereby removing uncertainty over the raw material. However, the benefits may take some time to accrue.

The consensus target price for the stock stands at Rs 168, as per analyst polled on Bloomberg in the month of May. These will be reviewed once the results for quarter and year ending March'15 as well as company's guidance for FY16 are out.