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Hindalco: Lower prices sink profits - Views on News from Equitymaster

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Hindalco: Lower prices sink profits
Nov 7, 2012

Hindalco has announced its standalone financial results for the quarter ended September 2012. Net sales for the company declined by 1.7% YoY while net profits declined by 28.6% YoY. Here is our analysis of the results:

Performance summary
  • Topline of the company declined by 1.9% YoY on back of lower volumes and lower LME aluminium prices.
  • Operating profits of the company declined by 22% YoY due to high input costs. Operating margins were down by 2.1% YoY.
  • Net profit declined by 28.6% YoY during the quarter. Net margins declined by 2.2% YoY.
  • For the half year ended September 2012, net sales and net profits declined by 0.9% YoY and 31.6% YoY.

Standalone financial performance
(Rs m) 2QFY12 2QFY13 Change 1HFY12 1HFY13 Change
Net sales 62,719 61,635 -1.7% 123,027 121,915 -0.9%
Expenditure 56,116 56,482 0.7% 107,762 112,130 4.1%
Operating profit (EBDITA) 6,603 5,153 -22.0% 15,266 9,784 -35.9%
Operating profit margin (%) 10.5% 8.4%   12.4% 8.0%  
Other income 1850 1,324 -28.4% 3637 4338 19.3%
Interest (net) 675 279 -58.7% 1342 1093 -18.6%
Depreciation 1741 1,728 -0.8% 3495 3432 -1.8%
Profit before tax 6037 4,471 -25.9% 14066 9597 -31.8%
Exceptional Item   -        
Tax 1012 882 -12.8% 2601 1760 -32.3%
Profit after tax/(loss) 5025 3,589 -28.6% 11465 7837 -31.6%
Net profit margin (%) 8.0% 5.8%   9.3% 6.4%  
No. of shares (m)         1914  
Diluted earnings per share (Rs)         10.5  
P/E ratio (x)*         10.7  
*trailing twelve month earnings

What has driven performance in 2QFY13?
  • During the quarter ended September 2012, Hindalco's topline declined by 1.7% YoY. Aluminium volumes were flat QoQ as power supply outage at both smelters in 1QFY13 extended into 2QFY13. However, alumina volumes were slightly lower and stood at 328 kt in 2QFY13 as against 335 kt in 1QFY13, largely on account of constraints in bauxite sourcing at the Belgaum refinery. Cost pressures in the form of higher coal and caustic soda prices persisted, but an improving product mix (downstream products contributed 48.4% in 2QFY13 as against 44% in 1QFY13) and higher metal premiums helped offset some cost pressure. Copper division revenue of Rs 40.6 bn as contribution from byproducts reduced. Copper production which had declined sharply in 1Q FY13 as the company had taken maintenance shutdown increased on a QoQ basis.

  • In 2QFY13, Hindalco's operating profit declined sharply by 22% on a YoY basis. The decline in operating profit was largely due to an increase in coal and caustic soda costs and lower metal production. Operating margins shrunk by 2.3% YoY and increased 0.7% on a QoQ basis. Operating profit was impacted due to the operational issues at aluminium smelters and lower by-product revenues. Power and fuel costs as a % of sales increased from 12% in 2QFY12 and 12.6% in 1QFY13 to 13.1% in 2QFY13.

    Cost breakup
    (Rs m) 2QFY12 2QFY13 Change 1HFY12 1HFY13 Change
    Raw Materials 46,231 46,188 -0.1% 82,246 82,684 0.5%
    % of sales 73.7% 74.9%   66.9% 67.8%  
    Staff costs 2,915 3,129 7.3% 5,416 6,031 11.4%
    % of sales 4.6% 5.1%   4.4% 4.9%  
    Power & fuel 7,528 8,065 7.1% 13,882 15,638 12.7%
    % of sales 12.0% 13.1%   11.3% 12.8%  
    Other Expenditure 4639 5304 14.3% 9175 11526 25.6%
    % of sales 7.4% 8.6%   7.5% 9.5%  
    Purchase of traded goods -5198 -6203 NA -2956 11526 NA
    % of sales -8.3% -10.1%   -2.4% 9.5%  
    Total operating cost 56116 56482 0.7% 107762 112130 4.1%
    % of sales 89.5% 91.6%   87.6% 92.0%  

  • Net profits registered a drop of 28.6% YoY. The underperformance in PAT was cushioned by dividend received from group companies and a sharp dip in interest costs. Interest cost for the quarter stood at Rs 279 m, 65.8% lower on a QoQ basis. The company has indicated that the decline is due to replacement of high cost debt.

What to expect?
MoEF (in consultation with the Cabinet) have formally approved the Stage I forest clearance for the Mahan Coal block (which is in a JV with Essar Energy). The GoM (Group of Ministers) on coal had cleared the coal block in May 2012 after the FAC (forest advisory committee) had denied clearance four times in the past. However the final approval from the cabinet was a pre-requisite for securing final Stage I clearance. While the stage I clearance, comes as a respite, and removes a major overhang, commencement of production is some time away. The block now needs stage II clearance, which in our view is not a cumbersome process and is subject to fulfillment of certain conditions. Post the above process, the company needs to acquire land, sign the mining lease with the state, and get the mining plan approved before it can start production. While the company believes production could start by end FY14, we conservatively build in a 9-12 month delay.

While the actual coal production could commence only post FY15, with meaningful contribution only from FY17, the approval is a sentiment positive for the company given the recent regulatory overhang on coal block allocation. Moreover, it will give a higher visibility on the profitability of the upcoming Mahan smelter, which is likely to start the commissioning process over the next few months. However given the cost escalations of Mahan and Utkal, we believe that return ratios for the Mahan project would tend to be sub-optimal in nature, despite commissioning of coal block.

We expect India aluminum margin to improve going forward as the production issues at Renukoot and Hirakud are behind us. We believe that the Utkal project commissioning remains a critical event given a) with captive bauxite it would be highly profitable and b) it is among the most delayed projects and commissioning would be EPS accretive.

At the current price of Rs 112, the stock trades at a P/BV multiple of 1.6x our estimated FY15 book value per share. We maintain our Buy view on the stock.

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