Higher aluminium prices spell good news for Vedanta, Hindalco

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Vedanta and Hindalco, which have seen a sharp rally on the bourses, seem set for more gains. The two companies are expected to benefit from rising aluminium prices (Vedanta will also gain from rises in other base metals), which should reflect positively on their earnings as well.

After consolidating during  April-July, aluminium prices  resumed their northward journey in August. Per-tonne aluminium prices on the London Metal Exchange (LME) crossed $2,000 levels in August, it trades close to $2,090. Thus, the aluminium price rally that took off from $1,450 level in January 2016 remains strong. And, prices are expected to remain firm for a longer period. 

Macquarie’s commodities team estimates higher-than-expected illegal aluminium capacity cuts in China, and hence has upgraded its aluminium price estimates by 4-9 per cent. It expects a bigger deficit in aluminium in 2017-18 with surplus emerging only from 2020. 

This is good news for Indian aluminium players, such as Vedanta and Hindalco. In the near term. However, Vedanta should see more gains as Hindalco has hedged its production at lower prices in FY18, say analysts. Vedanta, the base metals, iron ore and oil major,  is also benefitting from rising zinc production and prices. So, it’s not surprising that its share price scaled to Rs 320.20 in intra-day trade on Tuesday, levels not seen after April 2011. 

In the aluminium segment, Vedanta is also seeing a smooth ramp-up of its capacities. Because of the expansion at Jharsiguda-2 (3rd line of its 312,000-tonne capacity), Vedanta maintained the full-year output guidance intact at 1.4-1.6 million tonnes (mt) after  the June quarter results despite pot outages at its Jharsiguda-1 smelter during the quarter. Vedanta has continued to see its earnings getting upgraded led by volume growth across segments (zinc, oil, aluminium) and as price estimates for these commodities continued to improve. 

While analysts at Motilal Oswal Securities had recently upgraded their target price for Vedanta to Rs 360, Macquarie has given a target price of Rs 345. Both indicate further upside for the stock. 

For Hindalco, the higher aluminium prices, too, would accrue benefits, but partly offset due to the price hedging undertaken. Analysts at Jefferies said they believe Hindalco may not fully gain from the recent rally in aluminium prices as it has hedged around 56 per cent of its FY18 volumes, 13 per cent below spot aluminium LME prices. 

According to the company’s FY17 annual report, Hindalco has hedged 979,000 tonnes of aluminium volume (78 per cent of FY18 volume) at $1,796 a tonne. However, the positive is that the company also has forex hedges. 

Hedging gains related to these forex hedges would likely offset aluminium hedge losses and cushion the impact on FY18 Ebitda, analysts at Jefferies add. Also, only 20-odd per cent of FY19 volumes now seem to have been hedges, so rising prices should flow through to revenues and profits. 

So, while Hindalco’s FY18 earnings before interest, tax, depreciation and amortisation (Ebitda) estimates may not see many upgrades, FY19 will see operating performance and earnings getting upgraded. 

Not surprising then, Hindalco also has seen its stock scale multi-year highs on Monday, trading near Rs  245.60 levels. Jefferies’ target price of Rs 261 and now Macquarie’s at Rs 280 suggest there are more gains in the offing.

On the flip side, the news might not be so encouraging for Nalco, which also sells alumina (an input to make aluminium) apart from captive consumption. Alumina sales account for about 40 per cent of its gross revenues. 

Macquarie has downgraded alumina prices by 3-8 per cent over FY18-20. This is because illegal capacity cuts in China don’t cover alumina facilities, and if aluminium output is cut it will also reflect on alumina demand.

The company’s profitability, though, will continue getting support from captive coal and bauxite supplies as well as low cost of production. Macquarie’s target price stands at Rs 71 while other analysts such as those at Reliance Securities and Antique Stock Broking’s target prices range Rs 72-85 for stock trading at Rs 74.10 levels.

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