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Hindalco: Size does matter

Aug 31, 2002

Hindalco Industries Ltd. (HIL) is the largest primary aluminium producer in the country and amongst the lowest cost producers of the base metal in the world. The advantage seems to be a fallout of the company's presence in mining, refining, smelting with access to captive power facilities.

HIL: Capacity expansion
Alumina (MTPA) 210,000 660,000
Aluminium (MTPA) 100,000 342,000
Captive Power (MW) 150 769
Hindalco is in the midst of organic growth. To overcome current capacity constraints the company has undertaken Rs 18 bn brownfield expansion at its Renukoot facility. The company will increase smelter capacity by 100,000 tonnes per annum (TPA) and alumina refining capacity by 210,000 TPA. Aluminium being a power intensive industry, the company has also planned to augment power-generating capacity to 796 mega watts (MW) for meeting increased requirements. The expansion is anticipated to be completed by FY04.

Nalco: Crown Jewel
Replacement cost/ shareRs 229
No. of sharesNos. m 644
% stake acquired%46.0%
No. of shares acquiredNos. m 296
Acquisition cost Rs m 67,827
Having said that, with the privatisation programme gaining momentum in FY03, fresh opportunities are facing the company. Among the public sector companies on the disinvestment list is National Aluminium Company Ltd. (Nalco), the largest alumina producer in the country. Based on our replacement cost estimates, HIL will require significant amount of funds to pull through the bidding independently. Consequently, with funds likely to be blocked towards Nalco acquisition, the ongoing expansion exercise could be delayed. The company has not given guidance on meeting the earlier completion date target.

On July 21, 2002, the A.V. Birla group announced restructuring of group companies to create a non-ferrous major. Under the arrangement, the copper business of Indo-Gulf Corporation Ltd. will be merged with HIL. Shareholders of Indo Gulf will receive 1 share in HIL for every 12 shares held. Further, they will receive 1 share of the stand-alone fertilizer business, Indo Gulf Fertilisers Ltd., for every 5 shares currently held. HIL is also desirous of acquiring 100% control in it's subsidiary company, Indian Aluminium Company Ltd. (Indal). Consequently, the company has made an open offer for the balance 25.6% non-promoter shareholding at Rs 120/ share. On successful completion of offer, which could cost the company Rs 2.2 bn, HIL plans to de-list Indal.

Hindalco: Stretched target
(Rs m) HIL IndoGulf* Indal Merged**
Sales 23,314 21,650 13,684 58,648
Operating profit 9,940 4,468 2,217 16,625
OPM (%) 42.6%20.6%16.2%28.3%
PAT 6,860 2,419 1,171 10,450
No. of shares 74.5 225.2 71.1 104.2
EPS 92.1 10.7 16.5 100.3
Networth 62,410 9,770 9,302 81,482
Debt 5,730 7,679 3,972 17,381
Debt/equity (x) 0.1 0.8 0.4 0.2
Cash & cash equivalents 7,753 3,116 2,302 13,170
Free Cash Flows 3,858 2,297 875 7,029
*Estimated numbers **Assuming Indal merger, all nos. are estimates

We reckon, the restructuring is likely for enhancing the size of the balance sheet to increase the bidding capacity of the enlarged entity. We undertook an exercise to get a feel of the impact on the merged entity (including Indal). Assuming the merged entity is able to liquidate cash & cash equivalents to a significant extent and entirely use free cash flows, there could still be a shortfall of Rs 53 bn. Raising balance funds through borrowings is likely to considerably impact leverage ratio of the merged entity, which will increase the financial risk profile. Consequently, since restructuring announcement, the stock has declined from Rs 700 levels, as markets believe HIL will make a serious bid for Nalco.

But a successful bid will also result in inclusion of Nalco within the group. Nalco, which has a much lower leverage ratio compared to the merged entity, could positively impact financial leverage of the combined group. We reckon, operating profits of the combined group is likely to comfortably cover the higher interest outgo.

Having said that, based on financials of the combined entity, current valuations of HIL are low. But, valuations are reflecting the uncertainty in final outcome. Reports suggest several international majors are also likely to participate in the privatisation, which include Alcoa, Alcan, BHP Billiton and Kaiser. With increased competition bidding price for Nalco could get aggressive, which would adversely affect group financials. Consequently, investors are likely to remain cautious on Hindalco.

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