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  • MAY 7, 2012

Hindalco Industries: A commodity czar

The Indian aluminium players enjoy a sustainable cost advantage due to backward integration benefits. Indian aluminium companies lie in the first or second quartile in the global cost structure. And, Hindalco Industries is one of the largest and well known companies in the industry.

Hindalco Industries Limited, a Fortune 500 and Aditya Birla Group entity is the largest copper and second largest aluminium producers in India with a 51% and 33% market share respectively. Its aluminium production process encompasses the entire gamut of operations, from bauxite mining, alumina refining, aluminium smelting to downstream rolling, extrusions and recycling. A metals powerhouse with a consolidated FY11 turnover of about USD $15 bn, Hindalco is the world's largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia. Its copper smelter is the world's largest custom smelter at a single location.

In 2007, Hiindalco made an USD $6 bn acquisition of Novelis Inc. a world leader in aluminium rolling and can recycling. This move catapulted the company into the league of world's top 5 aluminium producers. It also enabled the company to have a global footprint in 12 countries outside India. Although the acquisition has made Hindalco the world's largest aluminium rolling company, resultant debt and Novelis depressed earnings with its can price ceiling contract and large exposure to the developed markets, remained one of the biggest overhang on Hindalco's performance till 2009. However, with the expiry of the can price ceiling contracts in 2009 and cost restructuring, Novelis has emerged as a successful acquisition for Hindalco with an improvement in profitability. Despite sales volume for Novelis still below 2008 levels, adjusted EBITDA has nearly doubled.

The future of Indian Aluminium Industry

India has the fifth largest bauxite reserves in the world with deposits of 3 bn tonnes. India's share in world aluminium capacity is about 3%. Indian producers are the lowest cost producers due to their captive power plants, cheap labor and proximity to supply of raw material (bauxite). The per capita consumption of aluminium in India continues to remain low at under 1 kilo gram (kg) as against 30 kg in US and Europe and 10 kg for China. Thus there is tremendous potential for growth in India.

Over the medium term, thrust on power sector capacity expansion will spur the aluminium demand. In the long term, outlook for aluminium in India continues to remain promising. An increase in the number of potential applications for which aluminum could be used is expected to spur demand for this metal. The government's thrust on infrastructure, in itself, is a crucial growth driver in the long run. Given the metal's inherent advantages over other metals, it is increasingly replacing others, thus leading to an additional demand boost. For example, the emphasis on increasing fuel efficiency and reducing pollution is forcing quite a few automakers to replace steel with aluminium as the latter's favourable weight to strength ratio and better conductivity helps increase mileage and reduce emissions.

Hindalco has also lined up some aggressive organic expansion plans whereby it will expand its alumina capacity to 4.5 m tonnes from current 1.5 m tonnes and aluminium capacity to 1.6 m tonnes from current 0.9 m tonnes, the last phase of which is expected to commence production by 2014. Considering the demand for aluminium is expected to grow at 6% to 8% per annum in view of the low per capita consumption in India, the capacity additions undertaken by the company will enable them to meet the growing demand. Hindalco being one of the largest producers of aluminium in India is well poised to capture the growing demand of the metal.

Challenges

The greatest challenge facing the industry is the continuous increase in raw material prices which are showing no signs of going down. Most input costs such as fuel oil, coal tar pitch, and caustic soda have increased along with the freight costs. Alumina costs for non integrated smelters have gone up and may increase further. Aluminium industry being a cyclical in nature depends heavily on the health of the world economy. Any slowdown in demand could have adverse effects on the profitability of the company. The European debt crisis and slowdown in world economy as well as fear of hand landing in the Chinese economy (which accounts for 40% of world aluminium demand) have already led to a decline in aluminium prices. The expansion plans of Hindalco are also facing some delays. Some of the projects are running behind schedule. This is due to delay in getting regulatory approvals. As a result the company has to incur additional cost which will put pressure on its margins in the short term.

Should Hindalco Industries Ltd be a part of your stock portfolio?

Hindalco's standalone business is robust being a low cost producer, with linkage for raw material and power. The company is the largest producer of aluminium and copper in India. As an investor, you have to account for the fact that this is a cyclical industry, but Hindalco is one of the best players in the sector. That means it all comes down to the price you pay. For now Hindalco does look cheap. Long term investors should buy the stock at current price.

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