Hindalco expansion leaves investors unimpressed

Last Updated: Wed, Jun 12, 2013 05:04 hrs

The greenfield aluminium production plant of Kumar Mangalam Birla-promoted Hindalco Industries at Singrauli in Madhya Pradesh started trial production in April this year. Built at an investment of Rs 10,500 crore, the plant, called Mahan, is a part of Hindalco's ambitious expansion plans that it embarked on four years ago to more than double its output.

However, investors don't seem too enthused about the plant's prospects in the short term. They are worried about the high cost of production due to the delay in final clearance for the coal block allotted to it in the Singrauli coal fields. Adding to their anxiety is the dim price outlook for light metals like aluminium.

Hindalco, in 2009, had set off on a $5.5-billion greenfield expansion to increase aluminium production from 0.6 million tonne to 1.3 million tonne per annum. The plan included a bauxite refinery in Utkal in Orissa to meet the alumina requirement of the Mahan plant and an integrated aluminium production facility, called Aditya, in Orissa. Both the plants are expected to complete in the current financial year.

Cost concerns
But their contribution to the company's profitability in the short-term is being doubted. "We maintain our cautious stance on the stock, given the weak aluminum price outlook, rising leverage and continuing concerns on return profile of the new greenfield smelter projects, given the delays," said Saumil Mehta, analyst at domestic brokerage IDFC Securities, in a recent report.

According to the company's guidance to analysts, the cost of production of aluminium at Mahan is expected to be about $1,800 per tonne in the absence of captive coal, up from $1,300 per tonne if it had access to reserves of alumina and coal. International brokerages such as Citigroup Global Markets expect it to be even higher at $1,950 per tonne. This is more than the metal's trading price of $1,923 on the London Metal Exchange on Monday.

Aluminium prices have been languishing for some time now. Prices peaked at $3,580 per tonne in July 2008 before crashing to $1,766 in January 2009 amid the global economic slowdown that followed the sub-prime crisis in the US. The price briefly recovered to $2,908.5 per tonne in May 2011, but the recent European sovereign debt crisis and the slowdown in China have crippled demand once again, bringing the price down. The future contract for the metal on the exchange for April 2014 and 2015 is $2,005 and $2,015 per tonne, respectively. It is only in 2016 that the contract prices show some recovery at $2,177 per tonne for April.

With prices remaining weak, the high cost of production will weigh on the company's finances. Hindalco has obtained stage-one clearance for the captive coal mines for Mahan. Transfer of land for forestation has been approved by the state government and the company is expecting the stage-two clearance in two to three months. But results won't be visible immediately as it will take about four quarters after that for mining to start. Meanwhile, the company has maintained its production guidance of 100,000 tonne of aluminium in 2013-14 and 300,000 tonne in 2014-15.

Key link
The cost of production of alumina at Hindalco's Utkal refinery in Orissa will be crucial to the profitability of Mahan. Typically, to produce one tonne of aluminium, two tonnes of alumina are required. Alumina in turn is extracted from bauxite (four tonnes of bauxite ore will yield two tonnes of alumina). The cost of production of alumina at Utkal is estimated to be $170 a tonne, but since the conveyor belt to transport bauxite from the mine to the refinery is still under construction, this cost is set to rise by about $30 per tonne, which in turn will raise the input cost for Mahan. The company expects to produce 400,000 tonne of alumina at Utkal in 2013-14 and 1 million tonne in the year after that.

Among its other projects, work on Hindalco's integrated project, Aditya, in Orissa, is on full swing. Its 359,000 tonne smelter is expected to be commissioned in the last quarter of 2013-14. The project will get coal from the captive Talabaria block in Orissa, and unlike Mahan, it is expected to get the approvals quickly as it does not have any forest land. The company expects the stage-one clearance for the block by September.

However, the greenfield plants are unlikely to contribute to the company's cash flows in a significant manner immediately. That's not good news for Hindalco which has seen its debt rise in recent years. Its net debt increased to Rs 45,721 crore at the end of 2012-13 from Rs 17, 681 crore four years ago. This has brought the net debt/equity ratio to an uncomfortable 1.23. As Aditya is still under construction, the debt is likely to rise further.

Debnarayan Bhattacharya, managing director of Hindalco, however, is not worried. "What we look at is the debt-service ratio, there is a number that we have committed to the lenders and we will honour it without any problem," says he. (The covenant varies depending on the lender and from company to company).

The company, on a consolidated basis, including its Canadian subsidiary Novelis, reported a 17 per cent drop in profit to Rs 2,941.7 crore in 2012-13, mainly owing to interest costs which grew 43 per cent to Rs 2,520 crore. Hindalco stock lost 29.4 per cent in the period to Rs 91.5 a share on BSE. The stock closed at Rs 94.5 on BSE on Tuesday.

Bhattacharya says, "Increased depreciation and interest will have an impact on profit before tax, but that we have to go through for a year, maybe a year-and-a-half. Things will begin to change after that". Hindalco's confidence comes from the performance of Novelis, the rolled aluminium plant that it acquired in 2007 for Rs 26,400 crore. The acquisition of the Atlanta-headquartered company has worked well for Hindalco, despite the initial hiccups that saw it writing off Rs 7,605 crore in goodwill impairment in 2008-09. Novelis generated free cash flow of $203 million (around Rs 1,100 crore) in 2012-13 on increased demand from the automobile sector in the developed markets and for can-body products in developing markets. In November, the company commissioned Asia's largest can recycling plant in South Korea which boosted its sales. It is now gearing up to meet the growing demand in Brazil, the host for the 2014 football World Cup and the 2016 summer Olympics.

Hindalco also expects to tap the demand for aluminium cans in India as its expansion at Hirakud for rolled products is near completion. The company plans to submit its product for inspection to can makers such as Rexam and Can-Pack by August and reach 100,000 tonne production in the next couple of years.

This along with upcoming Mouda Foils project (that will make aluminium foils) will help Hindalco improve its product mix and add more value-added products to its portfolio.

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