Hindalco: Lower prices sink profits

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.