Hindalco: Is there a need to panic? - Views on News from Equitymaster

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Hindalco: Is there a need to panic?

Apr 9, 2013

There has been carnage as far are stock prices of metal companies in India are concerned. Most of them are trading near their 52 week lows. Hindalco's stock price has corrected by 35% YTD as against 24% correction in the BSE metal index and 6% fall in the BSE-Sensex. While the fall in LME aluminium prices is a key factor, the stock correction has been much sharper than the LME price movement. In this article we list the reasons for the fall in the stock price.

What is the stock price factoring in?

  • The 2008-09 financial downturn created huge distortions in terms of demand compared to supply for aluminium. During financial crisis there was a significant drop in production but after, when demand recovered, even loss-making and idle capacity went back to the market. It was a mistake because, during the crisis, there was already a significant stock of aluminium that had been accumulated and, unfortunately, producers didn't allow for it to be digested by consumers. So the stock is still there. As a result, the global aluminium industry is in a state of oversupply. Demand from China (the largest consumer of aluminium) has also weakened due to slowing economy. Lower demand and higher supply has led to decline in aluminium London Metal Exchange (LME) prices.

  • Margin pressure to continue for the coming quarter (March 2013) - We have already seen margin pressure due to lower volumes and rise in input cost in December (2012) quarter. Cost will remain high and if the prices continue to fall there will be further pressure on the margins and earnings. As a result many analysts have already lowered their expectations and cut the earnings forecast for FY14. Part of this is already reflected in share prices. And if the situation worsens, their estimates could see further cuts.

  • The possibility of bauxite mining getting delayed which would sharply increase alumina and aluminum cost of production - The company is in the process of securing bauxite reserves in the states of Orissa, Maharashtra, Karnataka, Jharkhand and Chhattisgarh for supply to its alumina refineries. The acquisition of the resources is contingent upon the company securing various regulatory and licensing approvals as mandated by the government of India. Mining is an environmentally sensitive industry and any delay in obtaining timely approvals for new mines/renewal of previous licenses could affect the resource accretion to the company.

  • Hindalco has undertaken a massive expansion plan. After much delay, many of them are near completion. There is likely sharp increase in reported interest and depreciation as the projects get commissioned and flow through the P&L instead of being capitalized.
Is there a need to panic?

In our view, the key issue is ramp up of bauxite mining at the Utkal mine and once that is achieved the other issues become less relevant. We expect Utkal and Mahan to be commissioned over the next 3-4 months. In our view, while the capital costs (interest and depreciation) would increase, EBITDA generation should also start increasing from new projects. While initially it would be EPS dilutive, generation of cash profits from the projects would allow investors to add some value. Novelis (100% owned downstream subsidiary) remains on strong footing. LME aluminum prices have likely bottomed out and combined with premiums still offer the company attractive margins.

The upside we see in Hindalco is not much dependent on a rally in LME aluminum prices, but driven purely by company-specific issues, which positions the stock interestingly. There could be some short term pain as double whammy of declining product prices coupled with higher input costs could take a toll on the company's bottomline. But for long term investors there is no need to panic. Hindalco is still a fundamentally strong stock for long term investment. In our view, the stock is attractively priced and offers investors decent risk-reward at current levels.

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