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Hindalco: All’s well that ends well - Views on News from Equitymaster

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Hindalco: All’s well that ends well
May 2, 2006

Performance summary
Domestic non-ferrous metals major and the flagship company of the Aditya Birla Group, Hindalco, announced splendid results for the quarter ending March 2006 during the weekend. This was on the back of the improvement in business prospects of both its business – aluminium and copper. The company has benefited from better volume sales as well as higher realisations, with the commodity cycle strengthening further during the quarter. The operating margins have improved marginally YoY during the quarter. For the full year also, the company has managed decent growth in topline as well as bottomline despite the problems pertaining to its copper division during the year. However, this did affect Hindalco’s operating margins, which were lower by 100 basis points in FY06 as compared to FY05.

(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net Sales 25,156 36,574 45.4% 95,232 113,965 19.7%
Expenditure 18,871 27,276 44.5% 72,466 87,914 21.3%
Operating Profit (EBDITA) 6,285 9,298 47.9% 22,766 26,051 14.4%
EBITDA margin (%) 25.0% 25.4%   23.9% 22.9%  
Other income 750 743 -0.9% 2,700 2,439 -9.7%
Interest 380 624 64.2% 1,700 2,252 32.5%
Depreciation 1,396 1,443 3.4% 4,633 5,211 12.5%
Profit before tax 5,259 7,974 51.6% 19,133 21,027 9.9%
Tax 1,598 1,711 7.1% 6,464 4,502 -30.4%
Profit after Tax before extraordinary items 3,661 6,263 71.1% 12,669 16,525 30.4%
Extraordinary items 824 -   625 30  
Profit after Tax after extraordinary items 4,485 6,263 39.6% 13,294 16,555 24.5%
Net profit margin (%) 17.8% 17.1%   13.3% 14.5%  
No. of Shares (m) 928 986   928 986  
Diluted earnings per share       13.7 16.8  
Price to earnings ratio (x)         14.0  

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. The company also has a significant presence in the copper segment, which contributed 53% of the company’s revenues in FY06. However, despite the lower contribution by the aluminium business segment, it contributed to almost the entire share in profits of the company (99%) in FY06.

What has driven performance in 4QFY06?
Strong realisations lend a helping hand: Hindalco reported a 45% YoY growth in topline for the quarter ending March 2006. It must be noted that the company derives its revenues from two segments – aluminium and copper. In the case of the aluminium business, it was primarily higher average realisations in the region of about 10% to 25% YoY that helped the company register a 19% YoY growth in aluminum sales. Most of the product categories witnessed flat to negative volume growth during the quarter. However, contribution from alumina, which formed about 10% of the aluminium segment revenues in 4QFY05, increased to 14% in 4QFY06. This was on the back of average alumina realisations being higher by almost 20% YoY during March 2006, along with 43% higher volume sales. For the quarter, average alumina and aluminium prices on the LME were higher by 27% (14% YoY in FY06) and 79% (42% YoY in FY06) respectively. However, for the full year, both volumes and realisations have helped the company’s topline growth.

In the case of copper, the segment witnessed a strong 82% YoY growth in revenues, contributing to almost 76% of the incremental revenues of the company during the quarter. The copper division’s growth can be attributed to higher volume sales as well as better realisations. With copper prices on the LME being higher by 51% YoY during the quarter (37% in FY06), the company reaped significant advantages from the same. However, for the full year, the company’s performance was largely driven by stronger realisations, as both production and sales took a hit on account of various copper smelter-related problems.

Operating margins on the mend: The operating margins of Hindalco during the quarter rose by 40 basis points YoY, as both the business segments managed improved operational performances. This is despite significantly higher raw material costs like those of coal, caustic soda and furnace oil putting pressure on the profitability of the aluminium business. In the case of copper, higher semi-variable operating expenses despite lower production and expenses associated with maintenance and repairs have seemingly contributed to the damage.

Bottomline growth stronger than it seems: Led by the strong growth in the topline and a marginal improvement in operating margins, Hindalco reported a 48% YoY growth in operating profits. The profit before tax grew by 51% YoY, suppressed by a steep rise in interest costs, which the company has attributed to the increase in working capital requirements of Birla Copper. Further, while other income has remained flat, depreciation was higher by 3% during the quarter. However, a significantly lower tax outgo resulted in net profits (before extra-ordinary items) surging by 71% YoY. This was on account of two counts. Firstly, a reduction in the income tax rate from 36.6% in FY05 to 33.6% in FY06 and secondly, substantial tax-free treasury income. It must be noted that the reported bottomline growth of 40% YoY is depressed, owing to the fact that during 4QFY05, the company had written-back deferred tax of earlier years, resulting in higher profits. Thus, adjusting for the extra-ordinary items, PAT growth for the quarter and year ending March 2006 was 71% and 30% respectively.

What to expect?
At Rs 235, the stock is trading at a price-to-earnings multiple of 14 times its FY06 earnings. The company’s 4QFY06 has surprised our estimates on the upside, recouping much of its 9mFY06 under-performance, thus warranting an upgrade.

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. The company is witnessing increasing contribution from value-added products, which not only have better margins but the volatility in realisations is also low, which in turn would help curb the volatility in earnings for the company. Strong growth was witnessed in most of its domestic user industries like power (up 23% YoY), transport (32%), building & construction (22%) and consumer durables (15%), which is expected to continue going forward. Further, growth for the aluminium industry globally would be aided by strong consumption growth being witnessed in China. North America is also witnessing strong growth, led by the transportation and aerospace industries. In addition, demand from the Gulf, Europe and Japan would aid the demand from the construction sector. Moreover, with increased metal production capacities, Hindalco appears well-placed to continue to capitalize on the economic and industrial upturn.

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