The Hindu Business Line : Hindalco: Buy

HAVING just completed the stock-split exercise and an imminent rights issue, the Hindalco Industries stock could deliver attractive returns in the medium term. Fresh exposure can be considered in the stock, which trades at a multiple of about eight times its likely FY06 earnings.

Enriching product-mix in the aluminium business, improving outlook for the copper division, gains from capacity augmentation, synergies from the merger with Indian Aluminium (Indal), improving demand, a low-cost advantage that would weather price decline (if any) to a large extent and a positive outlook for prices are factors that make the stock attractive.

Its revenues and earnings growth have been fairly consistent while margins have remained strong.

The rising contribution of value-added products to revenues is likely to improve profitability.

However, the performance of Hindalco's copper division was subdued because of tough business conditions. Profitability in this segment during FY05 suffered mainly on account of low treatment charges and refining charges (Tc/Rc), lower import tariffs, reduction in export incentives and rising input costs. The operating profit margins for this division contracted from 31 per cent in FY04 to about 12.5 per cent in FY05. However, following a sharp recovery in the Tc/Rc in the second half of FY05, margins improved by about 220 basis points to 9.4 per cent in first quarter FY06 on a QoQ basis. The Tc/Rc rates are expected to stabilise at higher levels (about 20-30 cents/lb) in the near- to medium-term leaving scope for expansion in earnings.

The overall operating margins have remained fairly consistent at 35-38 per cent over the past few years. Return on shareholders' funds has been around 18 per cent for FY05. The company has, from time to time, announced shareholder-friendly measures such as dividend and bonus, while still managing to build on reserves.

Hindalco's merger with Indal is expected to result in better operating synergies and contribute to higher revenue growth in the aluminium segment. This has also strengthened Hindalco's balance-sheet. The net worth, on a consolidated basis, has risen to over Rs 8,700 crore, giving comfort to its gearing. It recently completed its brownfield expansion in Hirakud, raising its aluminium capacity from 65,000 tonnes per annum (tpa) to 1,46,000 tpa. Apart from this, it has also signed MoUs with the governments of Jharkhand and Orissa, where it proposes to set up integrated projects. This is likely to drive volume growth apart from enabling it to attain greater scale and competitiveness.

The company's thrust to source copper concentrate supplies from captive mines is likely to improve the profitability of the copper business. While the Mt Gordon Mines in Australia have commenced supplies, the Nifty Mines are expected to go on-stream later this year. The benefits of captive supplies that are expected to account for about 20 per cent of expanded requirements are likely to complement the gains arising out of cyclical improvements in the Tc/Rc markets. While this may not be significant, the company may have to rely increasingly on imports or enter into long-term supply contracts for copper feedstock. Of the two, imports would expose the company to the vagaries of price fluctuations — a principal risk in our view.

The demand from user industries such as electricals, automotives, building and construction is likely to remain high, lending optimism to company's business prospects. Rising investments in the power sector triggered by positive moves and reforms by the government is likely to place Hindalco in the list of beneficiaries. Its increasing presence in the downstream operations of the value chain (for primary metal) is another strong plus, which places it ahead of its nearest competitor, Nalco. Hindalco's marketing initiative of setting up aluminium galleries with a view to reaching unconventional segments such as architecture, retail and home furnishing is likely to augur well for its growth.

The risk element stems from the possibility of rise in input costs, which may strain the margins. This is more so, as the buoyant trends in the commodity price cycle for caustic soda and chorine products are likely to persist.

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