Hindalco’s debt reduction a tailwind for earnings
Lower interest cost allows more of Hindalco’s operating profit to flow to its earnings
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Hindalco Industries Ltd is on a mission to lower debt, using funds from equity-raising and internal accruals to repay borrowings. That’s a sensible strategy as its expansion is done and it can lighten its balance sheet till the next expansion comes calling. Lower interest cost allows more of its operating profit to flow to its earnings.
The company has prepaid Rs5,536 crore of debt so far, of which Rs4,505 crore was in April, which should result in further interest cost savings in the June quarter. This is important as interest alone ate away two-fifths of its operating profit in the March quarter. At the group level, debt refinancing by its subsidiary Novelis Inc. is expected to lower interest by $79million annually.
Savings on interest can be handy, as its operating profit margin front came under some pressure in the March quarter. Hindalco’s stand-alone sales grew splendidly during the quarter, rising by 18.4% sequentially but its expenses increased by 19.1%, leading to a 51 basis point lowering in its operating profit margin. Over a year ago, the margin declined by 1.4 percentage points, even as sales rose by 27.4%.
ALSO READ: Hindalco Q4 profit rises 25% to Rs503 crore
In its aluminium business, metal output was slightly lower compared to the December quarter. But its value-added output increased, where margins are better. The copper business saw output rise by 18.1% sequentially, recovering after a planned shutdown. Growth in output saw the copper business margins improve whereas the aluminium segment margins declined, which is what pulled overall margins down.
A lot depends on how the aluminium business fares in FY18. Since metal capacity is at optimal levels, the company’s ability to grow output of value-added products will determine how margins move. For now, aluminium prices will play a bigger role. On that front, prices have been holding firm but the strength of the rupee is a concern, as it lowers the landed cost of imports. The management said that regional premiums looked up in the fourth quarter.
The dip in Hindalco’s margins was a bit of a surprise and may be the reason why its share slipped post-results on Tuesday but still closed with a gain of 0.92%. It is up sharply since 24 May, having gained 8.7%. The company’s net profit rose by 25.3% over a year ago and by 57% sequentially, primarily due to lower interest costs and slower growth in depreciation.
Debt repayment can be a strong tailwind for earnings growth in FY18 but investors would also like to see margins climb back to higher levels. Its share has risen by 15% from six months ago, and trades at a valuation of 10 times its estimated FY18 consolidated earnings per share, based on a mean of estimates polled by Reuters.