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Hindalco: Its copper again! - Views on News from Equitymaster
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Hindalco: Its copper again!
Jan 30, 2006

Performance summary
Domestic non-ferrous metals major, Hindalco, announced poor 3QFY06 results. It is for the second consecutive quarter that the company has underperformed our estimates. Though there has been a respectable growth in topline, significant pressure on operating margins did the damage during the quarter. Higher non-operating (financial) expenses also played their part in depressing the bottomline of the company.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net Sales 24,901 28,737 15.4% 70,076 77,423 10.5%
Expenditure 18,436 22,907 24.3% 53,595 60,670 13.2%
Operating Profit (EBDITA) 6,465 5,830 -9.8% 16,481 16,753 1.7%
EBITDA margin (%) 26.0% 20.3%   23.5% 21.6%  
Other income 370 433 17.0% 1,950 1,696 -13.0%
Interest 441 628 42.4% 1,320 1,628 23.3%
Depreciation 1,095 1,314 20.0% 3,237 3,768 16.4%
Profit before tax 5,299 4,321 -18.5% 13,874 13,053 -5.9%
Tax 1,627 1,345 -17.3% 4,866 4,063 -16.5%
Profit after Tax before extraordinary items 3,672 2,976 -19.0% 9,008 8,990 -0.2%
Extraordinary items (199) 30   (199) 30  
Profit after Tax after extraordinary items 3,473 3,006 -13.4% 8,809 9,020 2.4%
Net profit margin (%) 13.9% 10.5%   12.9% 11.6%  
No. of Shares (m) 928 928   928 928  
Diluted earnings per share*       19.4 14.5  
Price to earnings ratio (x)         11.0  
(* trailing 12-months)            

The non-ferrous metals powerhouse
Hindalco, an AV Birla Group company, is India’s largest aluminium producer and has the distinction of being one of the lowest cost producers of the metal in the world. It is an integrated player, having captive bauxite mines, power units and high value-added output comprising semi-fabricated aluminium products. While the aluminium business of the company contributes to about 55% of the company’s revenues, it currently contributes to the entire share in profits of the company, as the copper business has been a drag on the company’s bottomline in 9mFY06.

What has driven performance in 3QFY06?
Strong topline growth: Hindalco ended the December quarter with a topline growth of 15% YoY. It must be noted that the company derives its revenues from two segments – aluminium and copper. During 3QFY06, revenues from the aluminium business were higher by 16% YoY. Much of this growth was contributed by the growth in value-added segments, both in terms of volumes as well as realisations. Segments like wire rods, rolled products and extrusions all contributed to the growth of the aluminium business. Strong alumina prices also helped matters with alumina sales being higher by 29% YoY, thanks to 25% higher realisations. The strong performance of the aluminium segments must be viewed in the backdrop of the 15% YoY rise in average aluminium prices on the London Metal Exchange (LME).

The growth in copper sales was at 14% YoY all of which could be attributed to higher copper realisations, as average copper prices on the LME were higher by about 35% to 40% during the quarter. However, lower volume sales on account of lower production by the company capped the performance of this segment. The lower production can be attributed to one of the company’s smelters taking a bi-annual maintenance shutdown for 25 days while another one witnessed a forced 19 days shutdown owing to minor metal leakage and resultant damage to nearby equipment.

Operating margins tumble: The operating margins of both the segments, aluminium as well as copper, were under pressure on a YoY basis. While the margins of the aluminium segment declined from 44% in 3QFY05 to about 40% in 3QFY06, that of the copper segment nose-dived into the negative territory to –3.5% in the quarter under consideration from 9% in the corresponding quarter of the previous fiscal. In the case of aluminum, while higher raw material costs like that of coal, caustic soda and furnace oil put pressure, in the case of copper, higher semi-variable operating expenses despite lower production and expenses associated with maintenance and repairs of a couple of smelters contributed to the damage.

Cost break-up
(% of net sales) 3QFY05 3QFY06 9mFY05 9mFY06
Stock in trade -0.7% -5.1% -3.3% -7.1%
Raw material 46.2% 55.9% 49.4% 54.8%
Staff Costs 4.2% 4.0% 4.5% 4.4%
Mfg Exp 20.1% 20.2% 21.1% 22.0%
Other Exp 4.3% 4.8% 4.7% 4.3%
Total Expenditure 74.0% 79.7% 76.5% 78.4%

Bottomline succumbs to the pressure: While operating profits were lower by 10% YoY, the fall in net profits was higher at 13% YoY. This was owing to higher interest outgo (up 42% YoY) on the back of increase in working capital requirements of Birla Copper. Depreciation charges also increased by 20% YoY, seemingly owing to the completion of the company’s copper expansion.

What to expect?
At Rs 160, the stock is trading at a price to earnings multiple of 11 times its trailing 12-month earnings. Further, the stock is trading at 1.4 times price to book value (P/BV) on the basis of our FY08 estimates. Owing to two consecutive quarters of underperformance by the company’s copper segment, the 9mFY06 performance of the company has been below our estimates. Further, since the company is unlikely to recover considerably in the final quarter of the fiscal, we will be revising our estimates downwards.

However, we remain positive on the prospects of the company as the outlook for both its businesses - aluminium and copper – remain promising in the medium-term. Increasing contribution from the sale of value added products would help curtail the volatility in earnings for the company going forward. Expected growth in power, transport and packaging sectors bode well for the company. Heightened construction activities in the country as well as the Gulf, Europe and Japan would aid the demand from the construction sector. Moreover, with increased metal production capacities, it is well placed to continue to capitalize on the economic and industrial upturn. We thus maintain our view on the stock.

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