Hindalco could weather aluminium volatility

With the volatility in global base metal prices, the stock price of Hindalco, the aluminium and copper producer, has fallen almost 15 per cent from its peak in October. On the London Metal Exchange (LME), the price per tonne of aluminium had touched $2,187 in early November; it is now around $2,000. Per-tonne copper prices on the LME have also slipped, to $6,600 after touching $6,967.

The break to the rally in base metal prices was caused by nervousness on the back of less than expected production cuts in China, the world's largest metal producer. The Street was expecting significant reduction there with the onset of winter, due to the effort there to bring down pollution.

Some analysts feel it is early to assess the impact of winter-related cuts; others, that aluminium prices would not fall much from here. Irrespective of the winter cuts, analysts say China's closing down of illegal smelters (estimated capacity of 3.5 million tonnes per annum or mtpa) are unlikely to be restored soon. Also, falling export from China, and high raw material costs (a bigger issue for non-integrated producers) will prevent a significant fall in aluminium prices.

Average aluminium prices during the September quarter (second or Q2 of the current financial year) were around $2,000 a tonne and despite correction in the December quarter, these are still close to Q2 levels. Thus, one might not see significant impact of the price corrections on performance of aluminium companies in Q3.

For copper, more than the benchmark prices, treatment and refining charges (TcRc) matter more. Negotiations are on between mining and smelting entities to arrive at the TcRC for 2018. Some producers had demanded higher TcRc but analysts feel the final one should be close to 2017 levels.

Cushion for Hindalco

Hindalco is an integrated entity, focusing now on cost efficiencies and value added products; it is also targeting debt reduction. All these should provide a cushion in any downside. The aluminium business, including US subsidiary Novelis, contributes three-fourth to consolidated operating profit. Novelis is only a convertor of raw aluminium to value-added products. For the domestic business, Hindalco has continued to hedge a significant part of output. Commodity hedges grew from 38 per cent of standalone revenue in FY16 to 82 per cent in FY17; about half of FY18 revenues remain hedged. This should allay some concerns on volatility in base metal prices.

Analysts at IDFC Securities say Hindalco’s earnings are now less sensitive to aluminium prices. UBS Global Research says upstream aluminium is not necessarily a huge driver of earnings (25-30 per cent of Ebitda or operating earnings). Operating profit in the current rising input cost environment also remains insulated, since the company is an integrated player. Rising alumina prices can push up costs for many other non-integrated entities, not for Hindalco.

IDFC Securities says Hindalco’s convertor businesses, i.e. Novelis (55 per cent of FY19's Ebitda) and copper (10 per cent) are expected to contribute 65 per cent to FY19's estimated Ebitda). More, 23 per cent of Hindalco’s FY19 aluminium volumes are hedged at $2,000/tonne. Thus, even if LME aluminium prices fall another five per cent to $1,950, it would impact FY19 estimated Ebitda by only six per cent, add analysts.

IDFC has reiterated its outperformer rating, for Hindalco, with a target price of Rs 322 for the stock, trading now at Rs 234. A foreign brokerage, too, has maintained a 'Buy' rating, due to a positive outlook for aluminium and the company’s focus on debt reduction. Analysts at UBS, on the other hand, have a target price of Rs 270, still higher than current levels.

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