Hindalco Industries Ltd’s new aluminium capacity is due to come on stream. Usually, having more to sell is a good thing as volumes and revenues both increase and profits swell too. There are obvious short-term hiccups: new plants take time to reach optimal capacity levels, and as a result initial costs can be higher, and also depreciation and interest cost on the new assets start hitting net profit margins immediately.
But once the plant is in full flow these problems typically melt into the background, the new plant’s improved efficiencies come to the fore, and sales and margins improve. That’s in a normal environment, but Hindalco faces the added uncertainty of higher capacity in a lousy business environment.
In the December quarter, its domestic aluminium business posted a segment profit margin of 9.3%, down 4.5 percentage points from a year ago but 1.3 percentage points higher sequentially. But go back two years in time, and this business had earned a margin of 23.5% in the December 2010 quarter, almost at the same level as a year earlier too.
Falling aluminium prices and rising input costs have pinched margins hard. A slowing world economy, especially in China, has affected both the aluminium and copper businesses. Recent months have seen good news coming out of China, as its appetite for metals appears to be improving. But Europe continues to be in a sluggish state and even India’s economic growth is insipid.
Hindalco’s revenue rose by 11.5% sequentially to Rs.6,871.7 crore in the December quarter, while its operating profit rose by 13%, and net profit by 20.8%. In its aluminium business, on a sequential basis, metal prices are a bit higher but regional metal premiums have turned lower, and input costs remain elevated. In copper, treatment and refining fees have risen a bit, which is good for Hindalco. Output has risen in both its businesses, recovering from production-related hiccups, which has aided its improved results.
The aluminium business is the one to watch for in the coming quarters and years ahead. In the near term, the company expects existing operations to benefit from a return to normal production levels. Stabilizing production in its new units is critical. Eventually, higher output should drive both revenues and profits, but the key is whether margins are sufficient to cover the higher interest and depreciation costs. An inventory overhang is likely to keep up pressure on London Metal Exchange prices.
Ultimately, the long-term outlook depends on a few factors. One is that domestic investment demand and consumption demand both improve, so that demand for aluminium grows. The same holds true for the global economy, especially China. Rising demand appears to be the only succour from weak metal prices. Second, a declining interest rate environment should also benefit Hindalco given its rising debt levels.
The third factor specific to Hindalco is that it also owns Novelis Inc., which sells processed aluminium such as beverage cans and car panels. Its competitor Alcoa Inc.’s results showed this business to be in good shape. Novelis’ results are due this week, and if it posts a good performance it will lift Hindalco’s consolidated results and even give some comfort to investors. On Friday, Hindalco’s shares fell by 3.2% after its results were announced.