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Alcoa has lowered its deficit forecast for aluminium in 2016 to 775,000 tonnes from the earlier 1.1 million tonnes. Photo: AFP/Getty images
Alcoa has lowered its deficit forecast for aluminium in 2016 to 775,000 tonnes from the earlier 1.1 million tonnes. Photo: AFP/Getty images

Alcoa earnings rub off on Vedanta and Hindalco

The rise in share prices of Hindalco and Vedanta appears a bit overdone, if Alcoa's results are the main reason behind it

Local metal stocks such as Hindalco Industries Ltd and Vedanta Ltd were up on Tuesday after Alcoa Inc.’s June quarter results showed a sequential 7% increase in revenue and 25% increase in Ebitda (earnings before interest, tax, depreciation and amortization). That is no doubt good but a fair bit of the improvement is due to Alcoa’s success in making productivity improvements and cutting costs. Domestic companies’ aluminium operations may not necessarily replicate that.

More caution is also warranted upon seeing its demand-supply forecasts. Alcoa has lowered its deficit forecast for aluminium in 2016 to 775,000 tonnes from the earlier 1.1 million tonnes. A sharp increase in China’s supply is the main reason, as its curtailments have fallen short. Since the deficit is still significant, metal prices are getting support but there is risk if China’s supply keeps rising.

One reason why China is producing more is higher prices. Alcoa’s realised aluminium price is up 3% sequentially. However, the premium paid by buyers to get quicker metal delivery is trending down. A 5 July Reuters report said Japanese buyers have negotiated a 19-23% decline in premiums for the July-September quarter, the first decline since the October-December 2015 quarter. Changes to warehousing rules on the London Metal Exchange to shorten delivery queues are one reason for lower premiums.

Another risk for domestic companies is that energy prices—crude oil and coal—have begun to move up. If lower energy prices had supported better performances in recent quarters, then they can hurt profits as well.

The basic aluminium price has been on an uptrend since June, which can partly make up for the dip in premiums. Local aluminium producers are still in a good position, especially as output is set to boom, with Alcoa projecting India’s output to rise by 13% in 2016. The problem will be if either aluminium prices start dipping and rising costs begin to eat into profitability.

The rise in share prices of Hindalco and Vedanta appears a bit overdone, if Alcoa’s results are the main reason behind it. Both companies also get significant contribution to profits from other commodities. Both companies also run custom copper smelting operations, while Vedanta also has zinc and crude oil operations. These can also influence their numbers. The next reality check for investors will be when these companies’ June quarter results are announced. Keep a watch on aluminium prices and premiums as well.

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