Hindalco: A market favourite may face a triple whammy

Hindalco had a great June quarter, posting record-breaking profit figures. Its consolidated profit after tax (PAT) had shot up to Rs 4,119 crore, which was a 48% rise from Rs 2,787 crore in the June quarter a year ago. Its consolidated Ebitda or operating profit had gone up to Rs 8,640, which was a rise of 27 percent year on year.

Both were all-time quarterly highs. Little wonder then that nearly all analysts covering the firm are bullish on the stock. At least 22 analysts have a buy call, and only two have contrary calls – one hold and one sell. The contrarians say that the performance could come under pressure because of slowing demand for beverage cans in the crucial US market, weakening housing/construction sector in the US that can impact specialities sales, and rising coal prices.

Also read: Market continues to take cues from macro data, global trends: Analysts

Trouble in the US

Around 60 percent of Hindalco’s operating profit comes from subsidiary Novelis.

Graphics by Upnesh Raval

Novelis makes a large chunk of its revenue (around 60 percent) from selling beverage cans in global markets, particularly the US.

Demand for beverage cans saw healthy growth of 10-12 percent between 2020 and 2021 but the brokerage Jefferies noted in its latest report that “inflationary pressures are now taking a toll”. Its analysts see significant weakening in sales growth. “While the industry was anticipating double-digit growth heading into 2023, Jefferies now sees demand rising at just 3.4 percent in 2022 and 2.5-3.0 percent in 2023-2024 versus earlier forecast of four to five percent,” wrote the analysts who have a hold call on the stock.

Analysts at Jefferies and ICICI Securities – which has a sell call in its August 11 report – cited slowing and even halted capex plans of Novelis’ biggest clients as an indicator. Novelis’ number one client, the Broomfield, Colorado-headquartered Ball Corporation, has announced that it is shutting down two of its beverage-can making facilities and postponing the setting up of a planned one because of weakening demand for alcohol. Another big client Luxembourg-headquartered Ardagh Metal Packaging too is struggling with slowing demand, especially for hard seltzer in the North American market. The management has said that they will “adjust” their capacity ramp-up to match that in their second quarter earnings call.

ICICI Securities’ analysts also point out that Novelis’ Ebitda “sits precariously” at over $500 per tonne “as weakening scrap LME spreads pose a clear risk”. Novelis uses a lot of scrap metal for its production, which helps improve its operating profits. But now the difference (spread) between the price of scrap and the spot prices quoted on LME is narrowing, which means competition can heat up.

Besides these, Hindalco faces weakening metal demand globally and margin pressures on its Indian aluminium business. “Impact of inflation (cumulated over the first half of FY23) can significantly mute aluminium Ebitda in the second quarter of FY23,” wrote the ICICI Securities’ analysts in their report. According to them, cost of production did not go up significantly for the company in the first quarter because of its low-cost inventory. But, in the aluminium Ebitda figures for second quarter of FY23, “the cumulative impact of higher inflation over the first half of FY23 will be visible”.

Margin pressure 

The Indian aluminium business contributes a third (30-35 percent) of the company’s operating profit and 16 percent of its revenue. “Global metal demand outlook weakened in 2022, led by real estate woes and Covid lockdowns in China, and tightening interest rate cycle elsewhere,” stated the Jefferies report.

While aluminium spot prices are trading at 20 percent below the June quarter average, per tonne cost has been rising for Hindalco in particular. “With Coal India diverting supplies to power, share of low-cost linkage coal in Hindalco’s mix fell from 60 to 50 percent, e-auction premiums rose, and Hindalco used higher-cost imports in the first quarter,” stated the Jefferies report.

Also read: Coal India’s stellar Q1FY23, largely thanks to coal shortage

The analysts expect global thermal coal prices to rise and remain elevated through the winter, and keep e-auction prices high. They see Ebitda per tonne falling to a half of what it was in the June quarter – from $1,333 in the first quarter of FY23 to $730-790 in the remaining FY23 and FY24. Jefferies has a 12-month price target of Rs 390. The stock is trading at Rs 425.9 as of September 9.