Company & History

With annual turnover over Rs. 20 Bn, Hindalco Industries Ltd. (HIL henceforth), the Aditya Birla flagship company, is one of the top ten Indian companies. It is the largest private sector aluminium producer in the country and enjoys the market share of around 44% of India's primary aluminium production. The company is an integrated producer with captive bauxite reserves and downstream production facilities and levers it to be one of the lowest cost aluminium producers in the world.

The company was incorporated in 1958, in collaboration with Kaiser Engineering Corporation of US. In FY94 Renusagar Power Supply Company, a 100% subsidiary, which had a 350 MW power plant, was merged into HIL..

Business & Operations


As mentioned above, HIL is one of the lowest cost aluminium producers in the world. The company does not trade in Alumina and uses entire production of the same in production of aluminium. Broadly, the products of the company can be classified in five categories. These are,

• Primary Aluminium, consisting of aluminium ingots, cast slabs, billets, wire and rods.
• Rolled Products, consisting of HR coils and plates, plain coils, panelling sheets etc.
• Extrusions like motor body, spare parts and heat sinks
• Foils

• Aluminium Alloy Wheels

HIL refines bauxite primarily obtained from captive mines, to extract alumina, which is smelted into aluminium ingots or billets. Almost 100% of the power requirements are met from in-house power plants. This is the reason behind the cost of power, which has traditionally stood at around 30% of the total cost of sales compared with the industry average of 40%. Besides the relatively low cost of power, the factors behind the cost effectiveness of the company’s operations can be summarized as i) access to high quality bauxite which the company acquires mostly from captive mines, ii) integrated operations spanning from alumina smelting to finished products, iii) alliances to outsource key raw material namely, caustic soda (which it sources from Bihar Caustics) and aluminium fluoride (which it sources from Tanfac Industries). It has helped the company in two ways. First, it shields the company from any sudden price and supply shocks and second, it allows the company to save on inventory cost.

In recent past, HIL has been moving away from low margin and low value addition businesses like ingots and rods to higher margin and more value added products like foils and extrusions. This is clear from the respective growth in production of different products this fiscal. During first nine months, the production of basic aluminium has increased by just 0.7% and that of wires has come down by a whopping 15.3%. However, the growth in extruded products has been rather high at 29% and that in foils much higher at 95%. This has also translated in higher margins for the company.

Industry Dynamics

Aluminium is a commodity and as such, is governed by the dynamics of the same and which at times are different from others. First and foremost, aluminium, just like other commodities is a non differentiable product and as such, realizations are dependent on aggregate demand and supply and not on the brand. Secondly, just like steel, the capacity additions are in spurts because of capital intensity and this leads to temporary price fluctuations. Third, there is an increased tendency in world majors to create huge economies through consolidation and this is leading to a more controlled but cartel like business environment.

Coming on to the demand scenario, we need to glance through the consuming sectors of aluminium. These are essentially electricity sector, transportation, packaging industry, consumer durable industry and machineries. As is amply clear, barring packaging industry, rest bear high correlation with the general health of any economy and as such the demand and prices fluctuate accordingly. In India, traditionally there was very high emphasis on electrical requirement and therefore, it was stipulated that half of the total aluminium produced must be useable for electrical purposes. Hence before decontrol of capacity expansion of 1991, 52% of total production was consumed in electrical sector, 19% for consumer durables, 10% for transportation, 8% for packaging, 5% for construction and the remaining 6% in other segments. This has since undergone a change and the proportion of electrical sector came down at 39%, primarily because of low addition of power generation capacity in nineties. That of transportation moved up to 17% and a marginal increase has been observed in packaging industry’s consumption. Even now the consumption of transportation is much lower than world average and therefore there is immense scope of growth in this sector.

Coming now to the wold demand and supply condition that defines the prices and also the level of cross border trade to a good extant, some very chaotic trends emerge. The US economy, which was on a rolling growth for around a decade has shown signs of slowing down. This means low offtake from that quarter. The demand growth in North America during year 2000 has been negligible at 0.7% compared to 7% in 1999. But that in Asia has been stronger, fuelled by the rebound of SE Asia. Overall world demand growth has been 5.6% and the growth in production has increased by 5.2%. The trend is expected to continue next year and this means a small shortfall. This has translated in a volatile price condition in recent times and the price is expected to hover in range of US $ 1500-1600 next year, as not much of capacity addition is on cards. Further, there has been a move by world majors in North America and Europe to consolidate and this will also contribute to prices remaining high. This means higher realizations for Indian players also.

Back home, prices have been firm for most part of the year and this has been despite the slow economic growth, reason being the reasonable demand from transportation sector. The economy is expected to pick up this year and this will further be helpful to the demand. Added is the factor of replacement of steel in transportation and wood in household and construction sectors also means higher demand. As of now India is marginally deficient in aluminium and as such, there is enough scope for capacity addition without making mush impact on prices.

Future Outlook

HIL has set Rs. 27 Bn total turnover target for current fiscal and an export turnover of Rs. 3.6 Bn. The company has been trying hard to move up to higher margin businesses and in this sequel, it is planning to reach the13,000 tons production target for aluminium foils for FY2001 is as compared to 7,537 tons in FY2000. The target for Indal stands at 7,443 tons of aluminium foils in same time period. Besides, the company is also expanding capacity and in this pursuit, is expanding Renukoot facility at Rs. 18 Bn cost. The project will be completed by year 2004 and will lead to a capacity expansion of smelting capacity by 100,000 tons, alumina refining capacity by 210,000 tons and power generation by 150 MW. Thus the company is trying to scale up operation on one hand to cash in on potentially increased demand and on other is migrating to higher margin segments. This means simultaneous migration yowards higher value addition and scalability of operation.

Financials

The net sales of the company has grown at a compounded rate of a little over 20.5% between 1997 and 2000 and stood at 20.31 Bn. in 2000. The operating profit grew at 21.75% and net profit growth was a little over 16%. The lower net income growth was on account of heavy depreciation expenditure, which grew at 47.5%. Understandably so as company is adding capacity. The result this year has also been impressive so far. The net sales has grown by 12.1% at 16.77 Bn. The operating income has shown a growth of 16.7% at 7.92 Bn and net profit stood at 5.21 Bn, a growth of 15.3%. More important shift, however, has been the growth in higher margin extruded and foil segments, which was much higher at 29% and 95% resp.

Valuations

The EPS of the company on annualized earnings of first nine months stands at Rs. 93.28. On CMP of around Rs. 800, the scrip is available at a discounting of just over 8.5. Prima facie it appears pricier than peers like NALCO (5.6) and Madras Aluminium (4.5). However, slightly deeper look reveals why. The operating margin of HIL is 47%, which is highest in industry except for NALCO. However, the margins of NALCO have jumped rather suddenly this year on a very low base and are yet to settle in a trend. However, the more important factor is that of operational capability. With dominant market share and integrated business structure, the company is better suited to exploit any growth opportunity and is on further expansion mode. Second, with key production inputs available either inhouse or at agreed terms, HIL is better suited to face any adverse situation on cost or supply front. In totality the scrip is good fundamental buy. However, the price at this point of time is slightly on higher side and as such investment can be contemplated on decline.

Recommendation: Hold, Buy on decline