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Hindalco: Growing at a fast and furious pace - Outside View by Luke Verghese
 
 
Hindalco: Growing at a fast and furious pace

In its effort to become a global player of some standing, the company appears to be stretching the limits of endurance

A very interesting past

The company has been around for more than 50 years now and it was the pet project of the late Ghanshyamdas Birla, the great grandfather of Kumar Mangalam, the current chairman of the board of Hindalco Industries. In an effort to emulate the Tatas, the late GD as he was better known as, had bid to set up the Rourkela steel plant. But unfortunately for him the congress party then under the dominating Nehru took a momentous decision at the Avadi conclave of the party that the steel industry would henceforth be the exclusive preserve of the Central Government, thereby putting paid to his plans. In an act of mollification he was granted an industrial license to put up an aluminium unit. It came up at Renukoot in Uttar Pradesh in technical and financial collaboration with the now deceased Kaiser Aluminium Corp of America. The Birla's ran the company from inception in what turned out to be a very fruitful partnership for decades. The Birlas' and Kaiser Aluminium ultimately almost had an acrimonious parting when the American company wanted to pull out and the Birlas realised that any fire sale by the Americans of their substantial holding in the company would render them vulnerable. Fortunately for all concerned the final parting between the two was on amicable terms. (The late Mohan Kumaramangalam the then steel minister and hard core commie also tried his level best to nationalise this company-but his efforts came up short).

The one momentous decision that the promoters took when the aluminium plant was set up was to simultaneously set up a 100% owned captive thermal power unit under the name of Renusagar Power Company. This power producer was an example of efficiency at its best as it consistently performed at 100 % of its productive capacity, and it was also a tough act to follow. It almost supplied the entire power needs of the company in an industry which is extremely power intensive, especially at the metal making stage. This company was subsequently merged with the parent.

Along the way it also acquired the very large operations of Indian Aluminium then a subsidiary of its Canadian parent, Alcan Aluminium, through fortuitous circumstances, after a then relatively unknown entrepreneur Anil Agarwal made an unsuccessful bid to swallow the company. Earlier the Mahindras has made an equally unsuccessful effort to merge Indian Aluminium with Mahindra and Mahindra when Keshub Mahindra was the de-jure chairman of the board of Indal. Hindalco is also the joint promoter of Idea Cellular and several other companies too.

The company subsequently affected a name change to its present offering to reflect the new reality or some such. It is today a humungous entity in terms of diversity, in terms of assets, and turnover, and the changing colours are in an effort to best the competition at their own game. But, then, the result is also that profit margins have taken a beating along the way. Add to it the innate conservativeness of the Birla group in sharing the good tidings of group companies with the investing public.

The current operations

Today its domestic operations are spread across the length and breadth of 10 states, and one Union territory, and it includes 18 separate operations that span aluminium and power, copper production, alumina plants which feed the raw material to make aluminium metal, coal mines, and myriad plants which make value added aluminium products like foils, sheet, extrusions, and so on. Its international operations today criss-crosses continents after it bought out Canadian manufacturer Novelis with its world-wide operations, which among other things is the largest North American manufacturer of beverage cans. Novelis itself was spun off from Alcan Aluminium the parent. Today, Hindalco's operations also stretch across Australia, Netherlands and several other nations across the globe. As is de-rigueur with corporate India, it also has a joint venture incorporated in the British Virgin Islands.

According to the related party disclosure schedule it boasts of 62 enterprises over which control exists and has another seven associate companies. There are also two joint ventures for added measure. The company has furnished its shareholding pattern in 18 subsidiaries where the management control ranges from 100% at one end of the spectrum to a low of 51%. Separately, in another schedule it has given the names of 20 subsidiaries, two joint ventures and two associates that have been included in the CFS of the group. CFS probably means the consolidated financial statement. It has also appended the brief financial data of 60 subsidiaries and step down subsidiaries of the parent in another schedule. Novelis Inc the Canadian offspring in which it has a 100% stake has 42 siblings of its own (and sporting such whacko names as 4260848 Canada Inc and 8018227 Canada Inc and so on) and another five associate companies. From the looks of it, it is a dumbfounding operation or some such. One wonders whether even the CEO has got a proper fix on matters.

The operational results

The standalone company ratted up 'net sales and operating revenues' of Rs 266 bn and a pre-tax profit of Rs 27.4 bn for the latest accounting year. The consolidated operations on the other hand trotted out humungous revenues of Rs 808 bn, but a pre-tax of a mere Rs 43.4 bn. The revenues of both the standalone and the consolidated group have shown an almost consistent increase in revenues each year over the 10 years, in the financial highlights that the company has provided. But it is very apparent that matters of profitability and profit ratios had to be sacrificed at the altar of asset and revenue growth, as the pre-tax profit has undergone a roller coaster ride of sorts over the 10 year period.

The interesting trend in its growth pattern is that the paid up capital over the decade has grown from a piddling Rs 920 m to a mere Rs 1.9 bn. This increase in capital was affected through a further issue of capital at substantial premiums to the face value in an effort to keep the debt from careening out of control or some such. (Ultimately, feeling the heat on its ability to generate adequate cash flow, the company has just resorted to raising more shareholder capital. At end March 2012 there is an additional share capital input of Rs 5.4 bn in the form of share warrants. The bigger issue is that presently the promoter shareholders control only some 32% of the outstanding equity, and hence any further share capital inputs have to be thought out very carefully to protect the interests of the promoter management).The preferential offer has been made entirely to the promoters who have the option to convert the warrants into equity shares at an exercise price of Rs 144.35 per share. That works out to a total exercise price of Rs 2165 bn. (This could also mean that some other group companies are also going to bleed as a result, given the cross holdings). Following the conversion the promoter's stake will go up by 5% points to 37.2%, it my math is on the button that is. The reserves and surplus rose more magnanimously from Rs 61 bn to Rs 313 bn over the 10 year period. The 'general reserves' and the 'surplus in the P&L account' together, account for 63% of this total. The securities premium account in the reserves schedule, at one point of time amounted to a hefty Rs 114 bn or more, till some accounting entries blunted this figure substantially.

Its capital assets

The point is also that the 'gross fixed assets including capital work in progress' has risen from Rs 64.7 bn at the beginning of the base year period to a humungous Rs 307.35 bn at the end of the base period. (This has to be seen in the light of the capital expenditure in each of the ten years. In 2011-22 for example the total capex was as much as Rs 84.5 bn). However the gross block at year end 'excluding capital work in progress' grew more sedately-from Rs 56.7 bn to Rs 145 bn over the same time span. The other interesting observation is that the gross block to turnover ratio moved in favour of the company over the years. The turnover was a mere 0.9 times the year end gross block in the year 2002-03. By 2008-09 turnover had grown to 1.4 times the gross block, and by 2011-12 it was even higher at 1.8 times. Thus the gross block was obviously not a stumbling factor in its ability to generate margins.

There were other tectonic shifts too. As would be expected and given the spate of corporate acquisitions, germinations, and other interested group investments that it also had to shoulder, the investment portfolio rose from Rs 26.5 bn in 2002-03 to touch a high of Rs 215 bn in 2009-10 before settling at Rs 181 bn at the end of the period. The funds inflow through the modicum of depreciation did contribute its mite - growing from Rs 16 bn to Rs 73 bn -but this effort was not quite enough. Consequently, and due to a variety of other reasons too, the dependence on borrowed funds accelerated from Rs 24 bn to Rs 146 bn. And, with increasing working capital needs, the net current assets grew from Rs 19.2 bn to Rs 53.2 bn placing a further strain on resources.

Management of finances

Most creditably enough the Interest costs did not increase manifold, though the interest costs debited to the P&L account seesawed over the years-amounting to a mere Rs 1.36 bn in 2002-03, to touch a high of Rs 3.4 bn in 2008-09, and then come down to an equally mere Rs 2.94 bn in 2011-12. On a rough basis, the 'interest & finance charges' paid out in 2011-12 and debited to P&L account amounts to 2% of the year end borrowings. (This is an absolutely brilliant achievement to say the least). The rest gets debited to gross block. In 2011-12 the amount of interest paid debited to capital account was Rs 7.2 bn. The total interest payout on a percentage basis works out to roughly 7%.This is an equally brilliant achievement.

This is also one company which simultaneously believes in loading itself with free cash. And at end 2011-12 the free cash amounted to as much as Rs 7.2 bn against Rs 2.3 bn previously. This higher year end sums can however be partly attributed to the share capital that it raised during the year and probably remaining unutilised at year end. Though there has been a sharp increase in book value of the investment portfolio as compared to the base year, the company appears to have been well rewarded through dividend and interest accretals in 2011-12.The total inflow on account of 'long term and short term investments' amounted to Rs 5 bn against Rs 3.1 bn previously. Dividend incomes got a big boost as the siblings were far more accommodating in the latter year, dishing out at inflow of Rs 1.3 bn against Rs 18 m previously. However, the difficulty in setting off these receipts as a percentage of the book value of its investment portfolio, is that, it is not clear whether the bank interest on its sizeable bank balances have also been included in this receipt schedule, as it does not appear to have been accounted for separately elsewhere. So the revenue return is only a rough guess at best.

The revenue breakup

Whatever, the company's revenues comprise of two parts-manufactured and traded. The former - comprising of alumina, aluminium & products, and others on the one hand, and copper, precious metals and DAP sales on the other, accounted for 99.3% of all sales, with traded sales bringing in the balance piddling sum. In the manufactured sales category, aluminium and products accounted for only 35% of such sales, while the latter accounted for the balance 65%.Traded sales comprise of copper cathode and, 'Others'. Then there is the contribution of 'Other operating revenues' of Rs 2.43 bn-whatever that is made up of. And bringing up the rear is the 'other income' receipts which at Rs 6.16 bn accounted for a not insignificant 22.5% of pre-tax profits. Other income played a much less crucial role in the preceding year accounting for only 13.4% of pre-tax profits. Other income also includes judicious dollops of write backs and such like, but that is an indelible factor of corporate accounting today. Though total revenues net of excise and excluding other income rose 11.5% to Rs 272.1 bn, the pre-tax profit excluding other income fell 5.6% to Rs 21.2 bn. The point is that consumption cost of raw materials etc - the biggest expense item by far--rose 12.6% to Rs 176.4 bn - and that is a crucial factor. More significantly, power input costs rose 29% to Rs 28.7 bn.

It appears that it is the copper segment that is playing the role of spoilsport in the margin equation front in the segmental results schedule. What exactly is the synergy between aluminium and copper is a moot point, as barring the fact that they are both metals and are also used in electrical conducting there is little else in common. More importantly, copper is characterised as a global commodity player dancing to the tunes of the prices at London metals exchange, while aluminium is more of a glocal commodity player and not subject to the vagaries of global prices. Besides, in this masala mix, what the company is doing doling out DAP fertilizers is beyond me, but let that be. Sales of DAP for the record amounted to Rs 4.2 bn. The segmental results reveal that copper, the bigger of the two revenue streams, generated a segmental percentage margin of only 4.5%, while the aluminium segment brought home the bacon with a margin of 20%. Probably the company will do well to spin off the copper unit into an independent legal entity.

Going forward

Going forward, the emphasis -thank god - appears to be on generating more steam from its aluminium business. Or, at least, this is what the annual report appears to be harping on. There is the Utkal Alumina International Ltd project-a separate legal entity --which will feed the alumina for the Mahan and Aditya aluminium projects. These two projects appear to be a part of the parent. Then there is the proposed expansion of its flat rolled products unit at Hirakud. There is also the Jharkhand aluminium project with a captive power plant in the anvil. The status of this unit is not known. Neither is the additional metal making capacity that will be available when these units come on stream. All this amounts to large sums of capital expenditure, the fruits of which will be visible some time into the future. The cash flow statement reveals the strain that the company is coping with, as it tries to handle its mega ambitions on the capital expenditure front, and on the portfolio investment front, and the inability to generate sufficient cash from internal resources.

The investment schedule is an eye-opener. The total book value of all its investments amounts to Rs 135 bn. Of this sum, Rs 124 bn is in unquoted securities and the balance in quoted securities. The investments are further divided into long term trade investments, other long term trade investments, and investments in money market instruments. (The sums invested in money market instruments amounts to a miniscule Rs 1 bn). The trade investments are further categorised into investments in subsidiaries, joint ventures, associates, and other entities and they include separately preference share investments. It has equity investments in 15 subsidiaries, two joint ventures, two associates, and nine other entities.

The siblings

The investments in subsidiaries amount to Rs 128 bn or roughly 95% of all investments. The investments in JVs amount to Rs 220 m, and the investments in associates at Rs 2.4 bn. And, bringing up the rear is the investments in other entities at Rs 3.1 bn. By far the largest single investment is in a subsidiary called A V Minerals (Netherlands) B.V. with an investment value of Rs 104 bn. This investments alone accounts for 77% of all investments. It has been affected at a price of Euro 61.2 per share. Way behind at the number two slot is the investment in Utkal Aluminium with an outlay of Rs 16.3 bn. And falling in at the No 3, No 4 and No 5 spots are Aditya Birla Minerals with Rs 4.8 bn, Idea Cellular with Rs 2.3 bn and Hindalco-Almex Aerospace with Rs 1.7 bn. Of the latter four companies, only Idea Cellular is an associate company. It also holds investments in other prominent group companies such as Grasim Industries, Ultra Tech Cement, and Aditya Birla Nuvo.

The brief financials of the 60 subsidiaries that it has furnished is a revelation. The point that becomes very striking is that only one company in this listing has declared a dividend. That company is Aditya Birla Chemicals which has declared a pip squeak dividend of Rs 11.7 m. But the financials of the parent state that the subsidiaries have ponied up a dividend of Rs 1.30 bn. (I am presuming that all these inflows relate to dividend payments made in the same year, and that all the subsidiaries are represented in the list). The results of its largest investment AV Minerals (Netherlands) is just as revealing. It is a holding company of sorts-no doubt about that. AV Minerals has a paid up capital of Rs 113.7 bn which is larger than the parent's 100% holding in it. It has negative reserves of Rs 21.2 bn and total assets of Rs 92.4 bn. But it registered NIL revenues and managed to register a loss of Rs 10.8 m. This must rank as a fantastic return on investment (ROI). How in heaven's name did it manage to accumulate losses of this magnitude especially when it appears to generate no revenues? Equally flummoxing are the financials of Novelis Acquisitions LLC - a step down subsidiary. It boasts of a negative capital base of Rs 85.4 bn and negative assets of Rs 85 bn. A zilch turnover followed by a loss before tax of Rs 7.5 bn. This is interesting. Is one also to understand that this company has gone fully belly up or what? It will help if corporates suo moto come clear on the meaning of such performance results.

There are numerous other incongruities such as this in the listing of its siblings. But enough is enough. Suffice to add that one should be careful when investing in such companies.

Disclosure: Please note that I hold 34,000 shares in Hindalco Industries.

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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