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Aluminium: Realisations drive growth
Nov 23, 2006

India is the fifth largest producer of aluminium in the world, accounting for around 5% of the total bauxite reserves (raw material for aluminium). India's installed aluminium production capacity is about 3% of the world capacity. The higher demand for the metal from the USA, Europe, China, Japan, India and South Korea helped strengthen the international prices. The effect of which was reflected in the second quarter September 2006 results. Realisations aid topline growth: With growing demand, aluminium prices strengthened on the LME. Average aluminum prices during the quarter were higher by 37% to 42% YoY. This resulted in the Indian aluminium producers reporting strong topline and bottom line during the quarter ended September 2006. The aluminium major Hindalco improved its product mix and high capacity utilisation levels (alumina – 100% and aluminium 103%) further helped it report 74% YoY growth in the topline. The value added products that enjoy better margins contributed to the extent of 57% to the revenues during the quarter.

Nalco reported a strong 37.7% growth in topline for the quarter ending September 2006, which could be attributed solely to better price realizations. Exports contributed to the tune of 50% of revenues, which has further fuelled growth, as realisations are higher for exports as compared to sales in the domestic market.

Second quarter September 2006 performance
  Nalco Hindalco
  2QFY06 2QFY07 (%) Change 2QFY06 2QFY07 (%) Change
Net sales (Rs m) 10,470 14,416 37.70% 26,608 46,342 74.20%
Operating profits (Rs m) 4,589 8,751 90.70% 4,879 9,864 102.20%
OPM (%) 43.80% 60.70% - 18.30% 21.30% -
Net profit (Rs m) 2,830 5,950 110.20% 2,765 5,976 116.10%
NPM (%) 27.00% 41.30% - 10.40% 12.90% -

Margins spiraling up: Since commodity players have high operating leverage, any significant improvement in realisations flows directly to the bottomline. Despite higher raw material costs putting pressure on the profitability of the aluminium business, aluminium majors’ margins leapfrogged during the period on account of better realisations.

The Hindalco’s copper business, which posted a PBIT loss of Rs 692 m in 2QFY06, has reported a profit of Rs 1.2 m during 2QFY07 due to improved Tc/Rc (treatment and refining charges) from its copper concentrate business. A combination of the copper division returning to profitability and improved aluminum business helped the company post higher operating profits.

Similar is the case for its competitor Nalco, strong realisations and increasing demand for aluminium has expanded operating margins by 1690 basis points. Bottomline has grown by almost 110% YoY on the back of growth in other income and reduced depreciation cost, also the company managed to curtail its cost by 3.7% YoY during the period under review.

Growing demand for inputs i.e. alumina and a favorable demand supply equation over the long-term are expected to have a positive impact in the coming quarters. The demand for the metal is increasing both in the domestic and exports market, which is reflected by strong LME prices. Going forward the demand will increase as the end user sectors like automobiles are on growth trajectory. Value-added products, not only have better margins but the volatility in realisations is also low. So companies resort to better product mix, as in case of Hindalco. We remain positive on the prospects of the company, as the outlook for the business remains positive in the medium-term.

Having said that, taking current valuations into account, risks appear to be on the higher side as any drop in international prices will have a negative impact on profitability and consequently the valuations. In order to minimise risks, we suggest buying such companies as close to its net asset values as possible.

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