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Aluminium: Comparing metal - Views on News from Equitymaster
 
 
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  • Apr 25, 2003

    Aluminium: Comparing metal

    When we think of size in the aluminium industry, the first name that would come to our mind would be the international aluminium major, Alcoa. However, if one considers some of the lowest cost producers of aluminium in the world, Hindalco cannot be missed out. In this article, we take a look at how these two companies compare on various parameters.

    To begin with, here is a brief description of the two aluminium majors. US major Alcoa Inc., world’s leading producer of aluminum, has a capacity of about 3.9 million tonnes (MT) which is nearly 1/6th of the world capacity. On the other hand, Hindalco is the largest domestic private player with an aluminium capacity of 342,000 tonnes. However, if we take into consideration, the capacity of the soon-to-be-merged Indian Aluminium (Indal), then the capacity increases to 414,000 tonnes (2% of global capacity). The company has a 50% market share of the domestic aluminium capacity.

      Alcoa* Hindalco*
    Production (MT) 3.5 0.3
    Market Cap. (US$ m) 19,234 953
    Sales (US$ m) 20,263 470
    Operating margins (%) 2.5 33.6
    Net profit margins (%) 2.1 21.7
    EPS ($) 0.5 1.4
    Production/employee (tonnes) 28 20
    ROE (%) 4.2 8.6
    Market Cap/Sales 1.0 2.0
    Price/Book Value 1.9 0.8
    Price/Earnings (x) 45.8 9.3

    *All figures for Alcoa are for the calendar year 2002
    **All figures for Hindalco are 9mFY03 annualised
    Note: Rs 48 = US$ 1
    Note: P/E(x) as on April 22, 2003

    Beginning with the size of the two companies, Hindalco is nowhere near the international major. It can be seen in the table above that the market capitalisation of Alcoa is nearly 20 times that of Hindalco whereas, its sales are almost 50 times! Of course, these numbers must be viewed in the backdrop of the fact that Alcoa produced 3.5 MT of aluminium while Hindalco’s production stands at 0.3 MT. Alcoa has presence in 39 countries and supplies to the likes of Boeing (aerospace industry accounts for 7%-8% of the company’s total sales).

    But on the operational front, Hindalco is far more efficient than its global counterpart, which is reflected in the operating margin. The reason for lower margins for Alcoa was attributed to the weakness in the general manufacturing environment, more specific to aerospace and telecommunication sectors.

    Two things must be noted here. One, average aluminium prices on the LME fell from US$ 1,445 in 2001 to US$ 1,350 in 2002 i.e. 6.6% fall. Second, almost 50% of the company’s sales came from the engineered (used in transportation and building & construction) and flat-rolled products (packaging and consumer market) sales. The sales in these two segments registered a decline of 7% and 13% respectively. Moreover, Alcoa’s 2/3rd. sales are in the US alone and hence, its performance is affected by the domestic economy behaviour.

    Now here it can be argued that since aluminium prices were on a decline, why is it that Hindalco was not affected much? For one, the aluminium prices in India are adjusted with a lag effect only after the international price trend is certain. Moreover, there was a price fall on the domestic front also, though not as severe as international aluminium prices. Also, since exports account for only about 15% of total company sales, it was more or less insulated from the large fluctuations witnessed in the international markets.

    However, all is not bad at Alcoa. To back this argument, the production per employee figure is something that is relatively better for the company as compared to Hindalco. While Hindalco produces 0.3 MT with a workforce of about 12,000 employees, Alcoa produces 12 times more aluminium with a workforce of 127,000 employees. Hence, the figures of 28 tonnes per employee for Alcoa and only 20 tonnes per employee for Hindalco. Another parameter where Alcoa scores over Hindalco is the market cap/sales ratio, which is at 1 for Alcoa while it is at 2 for Hindalco. It must be realised here that the lower this ratio is, the more attractive the value of the company is. However, considering a single parameter does not conclude valuations of a company.

    The favourable story for the international major ends and now we see how is Hindalco superior to Alcoa. The biggest and the most important thing that distinguishes the two companies apart is the operating cost of production of aluminium. This cost for Hindalco is much lower at about US$ 870 compared to world average of US$ 1,180 and Alcoa’s cost of production at US$ 1,270. The advantage for the domestic major is that it has access to huge captive bauxite reserves and power plants, which helps it to lower costs. This explains in part the high operating margins for the domestic major.

    On other valuation fronts also, Hindalco seems a better story. The price/book value of Alcoa is at 1.9 times compared to 0.8 times of Hindalco. Moreover, on the price/earnings front, Hindalco is trading at 9x its 9mFY03 annualised earnings while Alcoa is trading at 46x its 2002 earnings! It must be noted here that 2002 was a second year wherein Alcoa disappointed investors by its results. The company’s profits fell from its peak of US$ 1,500 m in 2001 to the current US$ 420 m in 2003. With a return on equity (RoE) at 9% for Hindalco compared to 4% for Alcoa and with the domestic industry growth prospects comparatively better than its international counterparts, it remains to be seen if the markets give Hindalco its deserved valuations.

     

     

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