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Hindalco: The dollar sting - Views on News from Equitymaster
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Hindalco: The dollar sting
Nov 1, 2007

Performance summary
  • Net sales grow 7% YoY during the quarter, driven by higher copper sales.
  • Spiraling costs lead to a 7% YoY drop in operating profits as margins contract by 270 basis points.

  • A 30% drop in depreciation and lower effective tax rates help bottomline post an 8% growth over the corresponding previous quarter.

(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 46,342 49,597 7.0% 89,079 96,376 8.2%
Expenditure 36,478 40,380 10.7% 69,881 78,316 12.1%
Operating profit (EBDITA) 9,864 9,217 -6.6% 19,198 18,060 -5.9%
EBDITA margin (%) 21.3% 18.6%   21.6% 18.7%  
Other income 1,108 1,098 -0.9% 1,884 2,344 24.4%
Interest (net) 515 632 22.7% 1,149 1,194 3.9%
Depreciation 2,080 1,446 -30.5% 3,421 2,874 -16.0%
Profit before tax 8,377 8,237 -1.7% 16,512 16,336 -1.1%
Extraordinary income/(expense)            
Tax 2,401 1,809 -24.7% 4,521 3,879 -14.2%
Profit after tax/(loss) 5,976 6,428 7.6% 11,991 12,457 3.9%
Net profit margin (%) 12.9% 13.0%   13.5% 12.9%  
No. of shares (m) 986.0 1,111.0   986.0 1,111.0  
Diluted earnings per share (Rs)*         23.5  
Price to earnings ratio (x)*         8.4  
(* on trailing twelve months earnings)

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.

What has driven performance in 2QFY08?
Let us have a look as to how the two main segments of the company viz. Aluminium and Copper performed during the quarter:

Aluminium: The segment accounted for 36% of the company’s total revenues during the quarter as opposed to 40% in 2QFY07. Not surprisingly then, the growth in revenues was lower than the company’s total revenues. Though the division recorded its highest ever aluminum production during the quarter and grew by 8% YoY, it is the adverse exchange rate that led to the decline in realisations and ultimately, the 4% decline in the division’s revenues. It should be noted that as opposed to the same quarter last year, rupee has moved up by around 11% against the dollar and this affected the realisations from the segment. However, increased sales of value added products and tight control on costs enabled the company to restrict the damage at the EBIT levels.

Copper: The continued strong performance of the copper division did provide some solace to the topline of the company. Courtesy higher volumes and realisations, the division was able to increase its revenues by 14% YoY during the quarter. However, a significant 15% fall in Tc/Rc (key determinant of the profitability of the copper division) resulted into an EBIT margin growth of a mere 2% YoY during the quarter. Infact, had it not been for a better by product realization and improvement in operational efficiency, the damage would have been even severe.

Segmental break-up…
(Rs m)            
Aluminium 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Revenues 18,520 17,850 -3.6% 35,062 35,387 0.9%
PBIT 6,710 6,621 -1.3% 13,835 13,044 -5.7%
PBIT margin 36.2% 37.1%   39.5% 36.9%  
             
Copper            
Revenues 27,825 31,783 14.2% 54,042 61,045 13.0%
PBIT 1,233 1,261 2.3% 2,211 2,384 7.8%
PBIT margin 4.4% 4.0%   4.1% 3.9%  

As far as the overall EBITDA margins of the company are concerned, barring power and fuel costs, all the other three cost heads witnessed appreciation and hence, pulled down the margins by a significant 270 basis points. On the other hand, an 8% YoY drop in power and fuel costs was driven by increased use of captive resources as opposed to the state grid, which is relatively more expensive.

Cost break-up…
(Rs m) 2QFY07 2QFY08 Change
Raw materials 27,142 31,114 14.6%
% sales 58.6% 62.7%  
Staff cost 1,312 1,560 18.9%
% sales 2.8% 3.1%  
Power and fuel 4,946 4,568 -7.6%
% sales 10.7% 9.2%  
Other expenditure 3,078 3,138 1.9%
% sales 6.6% 6.3%  

Growth in the bottomline at 8% has been better than the performance at the operating level where profits fell 7% YoY. A 31% YoY decline in depreciation charges and a lower effective tax rate were the key factors responsible for the same. Net profit margins were higher by a marginal 10 basis points.

In recent quarters
As seen from the table below, rising rupee and inflation have been hurting the margins of the company. Further, with metal prices not moving as sharply as in the past, Hindalco has had no option but to take a hit on profitability.

over the last few quarters
  2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Net sales (YoY growth %) 74.2% 62.1% 29.8% 9.5% 7.0%
OPM 21.3% 22.4% 12.9% 18.9% 18.6%
NPM 12.9% 13.8% 15.2% 12.9% 13.0%

What to expect?
At the current price of Rs 198, the stock is trading at a multiple of 8.4 times its trailing twelve-month earnings. We are in the process of updating our research report on the company and will soon come out with our forward estimates for the same.

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