Near-term profit woes for Hindalco's India biz amid high energy costs

Margin recovery expected in the second half of FY23

Consolidated results of Hindalco beat Street expectations in the June quarter for the 2022-23 financial year (Q1FY23), reporting an operating profit of Rs  8,640 crore, up 27 per cent year-on-year (YoY) and 13 per cent on a sequential basis. The profit after tax from continuing operations was up 26 per cent, to Rs 4,119 crore (6.7 per cent higher quarter-on-quarter or QoQ). Net sales were up 4 per cent on a sequential basis while they were 40 per cent YoY, at Rs 58,018 crore.

Lower than expected costs in aluminium operations and strong by-product realisations in the copper division led to the better-than-expected result. Hindalco’s subsidiary, Novelis, had strong margins of $583/tonne. The Novelis guidance was upgraded by 5 per cent to $525/tonne despite worries regarding inflation and recession. Novelis projects solid cash flow generation this fiscal.

But India operation earnings would be under pressure in near term due to a combination of a fall in London Metal Exchange (LME) prices and high energy costs (up 32 per cent QoQ) at Rs 2,520 crore. There is likely to be a margin recovery, only in the second half. based on restoration of coal supplies by Coal India and hopes of stable LME prices.

The volumes of aluminium and copper sales declined by 4 per cent each (QoQ) while blended realisations for aluminium contracted 5 per cent QoQ. But costs may be stabilising since it was much less than the earlier company guidance of 15 per cent QoQ increase. Some low-cost finished inventory was also absorbed. The aluminium segment’s operating profit was Rs 3,320 crore, down 18 per cent, but the copper segment’s profit rose 46 per cent QoQ to Rs 570 crore due to strong realisations for by-products like sulphuric acid in the copper smelting process.

The management maintained capex guidance for the financial year at Rs 3,000 crore in India operations with an aggressive focus on downstream capacity expansion and a target of mid-teens internal rate of return for any upcoming projects.

Downstream aluminium volumes in Q2FY23 will increase by 7-10 kilotons since Q1 was hit by supply chain bottlenecks. The coal linkage share is expected to increase to 60-65 per cent in Q3FY23 due to increased supplies from Coal India (current linkage is 50 per cent). The Q1 share of expensive e-auction coal was 31 per cent and rest was contributed by expensive imports and captive mines. The copper segment profit will stabilise at Rs 400 crore/quarter with normalisation in acid realisations. The alumina sales volume target is 450 kiloton (kt) for 2022-23, with 150kt in Q2, 2022-23. Around 30 per cent of expected aluminium volumes are hedged at $2,500/ton for 2022-23.

Although the company continues to target deleveraging in the long term (current debt to equity ratio is around 0.6), the consolidated net debt rose from Rs 39,100 crore in FY22 to Rs 42,200 crore in Q1, 2022-23 with Novelis, and India business, both, seeing higher debt. Management attributed this to rising working capital needs and higher inventory levels, and elevated raw material costs.

Analysts tracking the stock continue to offer positive ‘buy’ recommendations. Hindalco is up 25 per cent in the last month, which is way better than the Nifty50 (up 10 per cent). At the current market price of Rs 436, it has ‘buy’ recommendations with 12-month target prices ranging between Rs 520 to Rs 580.