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Hindalco: Difficult quarter! - Views on News from Equitymaster

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Hindalco: Difficult quarter!
May 7, 2007

Performance summary
Hindalco, the flagship company of the Aditya Birla Group, has experienced margin pressure, both during 4QFY07 and full year ended FY07. However, the impact has been more pronounced during 4QFY07, as despite a robust 30% YoY growth in topline, the growth in bottomline has been restricted to 15% YoY, due mainly to a 330 basis points contraction in operating margins. While the company’s continued efforts to improve product mix on account of higher sales volume of value added products helped it to achieve 61% YoY growth in net sales during FY07, rising cost of production impacted operating margins (contracted by 100 basis points) and resulted into a slightly lower bottomline growth of 55% YoY over FY06.

Financial performance snapshot
Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net Sales 36,574 47,489 29.8% 113,965 183,130 60.7%
Expenditure 27,276 36,990 35.6% 87,914 142,980 62.6%
Operating Profit (EBDITA) 9,298 10,499 12.9% 26,051 40,150 54.1%
EBITDA margin (%) 25.4% 22.1% 22.9% 21.9%  
Other income 743 1,233 65.9% 2,439 3,701 51.7%
Interest 624 577 -7.5% 2,252 2,424 7.6%
Depreciation 1,443 1,576 9.2% 5,211 6,381 22.5%
Profit before tax 7,974 9,579 20.1% 21,027 35,046 66.7%
Tax 1,711 2,366 38.3% 4,502 9,403 108.9%
Profit after Tax before extraordinary items 6,263 7,213 15.2% 16,525 25,643 55.2%
Extraordinary items 30
Profit after Tax 6,263 7,213 15.2% 16,555 25,643 54.9%
Net profit margin (%) 17.1% 15.2%   14.5% 14.0%  
No. of Shares (m) 1159 1159   1159 1159  
Diluted earnings per share         22.1  
Price to earnings ratio (x)         6.6  

What is the company’s business?
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. Its integrated operations and operating efficiency have positioned the company as Asia's largest integrated primary producer of aluminium and among the most cost efficient producers globally. Its copper smelter is today the world's largest custom smelter at a single location. The company has a significant market share in all the segments in which it operates. It enjoys a domestic market share of 42% in primary aluminium. The company also has a significant presence in the copper segment, which contributed 53% of the company’s revenues in FY06.

What has driven performance in 4QFY07?
Respectable topline: Driven by strong aluminium prices on the LME and an improved product mix on account of higher sales volume of value added products, the company reported 30% YoY growth in net sales during 4QFY07 and 61% YoY for the year ended FY07. Apart from higher capacity utilisation, improved realisation and strengthening of operational efficiencies, the robust performance was achieved on account of the company’s efforts to maintain a mix of forward contracts and spot sales.

During the quarter, performance of the aluminum business was quite impressive on account of its continued efforts to improve product mix. Of the total volume sales, the share of the value added products was 52%. This has helped company to witness growth despite lower alumina prices in the international market. As far as copper business is considered, increased sales volumes and improved realisations on account of higher LME prices led to 40% YoY growth in copper revenues.

Segmental snapshot…
  Copper Aluminium
(Rs m) 4QFY06 4QFY07 Change 4QFY06 4QFY07 Change
Revenues 19,317 27,112 40.4% 17,263 20,424 18.3%
PBIT 1,201 1,365 13.7% 7,131 7,902 10.8%
PBIT margin (%) 6.2% 5.0%   41.3% 38.7%  

Cost concerns: Higher raw material costs like those for coal, caustic soda and furnace oil have pressure on profitability, especially during 4QFY07, where operating margins have declined by more 330 basis points. Furthermore, the company had to resort to buying bauxite from third party, which further put pressure on the cost structure. The impact on the full year performance has been rather muted, as the drop in operating margins at 100 basis points was not that steep.

Cost break-up (as a % of sales) 4QFY06 4QFY07
Consumption of Raw Material 51.2% 56.9%
Staff cost 3.4% 3.1%
Power & fuel 13.1% 9.0%
Other expenditure 6.9% 8.9%
Total expenses 74.6% 77.9%

Bottomline succumbs to the pressure: The drop in margins is reflected at the net level also. Though the net profits witnessed 15% YoY growth during 4QFY07, margins contracted by almost 190 basis points. Had not the other income witnessed 66% YoY growth, the net profits would have reported merely 8% YoY growth. Rising cost of production has also marginally impacted full year’s profitability. Further, higher interest outgo (up 8% YoY) on the back of increase in working capital requirements and higher depreciation charges have put downward pressure on margins.

What to expect?
At the current price of Rs 146, the stock is trading at a price to earnings multiple of 6.6 times its trailing twelve month earnings. The company is witnessing increasing contribution from value-added products, which not only have better margins but also lower volatility in realisations. While the core business looks good, a lot will depend on how quickly, the company brings Novelis, its biggest acquisition to date, back on track.

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