Stock pick of the week: Why analysts are betting on Hindalco Industries
Healthy growth in consolidated revenue, likely turnaround in the aluminium industry, good performance of its subsidiaries and steady free cash flow have made it favourite.
The expected improvement in the aluminium industry is another reason for analysts’ bullishness on Hindalco. Subdued global aluminium prices— 23% fall over the past year— have hurt aluminium manufacturers such as Hindalco.
However, analysts don’t expect global aluminium and alumina prices to fall any further because the Chinese authorities have suspended alumina production at three big refineries. These make up around 5% of global alumina supply and the production cut should support prices.
Pro-active hedging tactics should also help Hindalco report better performance in 2019-20. For example, around 15% of its expected production is hedged at around $2,200 (Rs 1.53 lakh) per tonne, significantly higher than the current global aluminium prices of around $1,765 (Rs 1.23 lakh) per tonne. More importantly, around 30% of its dollar exposure is hedged close to Rs 75, significantly higher than the current value of Rs 69.40.
Though 65% of Hindalco’s consolidated revenue comes from value-added products, it is usually treated as a proxy for aluminium prices and valued as a core aluminium manufacturer. Even Hindalco’s 35% core aluminium production business deserves better valuation because the company is one of the cheapest aluminium producers in the world.
Value-added products contribute more than core production to the company’s copper operations as well. With improvement in its copper cathode production, its Ebitda (earnings before interest, tax, depreciation and amortisation) margin should improve further. This means that Hindalco offers a clear risk-reward advantage for long-term investors.
However, potential investors should be ready for short-term pressure in this counter. Though Novelis, Hindalco’s Atlanta-based subsidiary, reported steady performance in the fourth quarter of 2018-19, it may remain under pressure in 2019-20 because of the global slowdown in the auto sector, especially in key markets like China.
Despite pricing pressures and capex, Novelis has generated free cash flow (FCF) of around $400 million (Rs 1,389 crore) during 2018-19. However, FCF may turn negative in 2019-20 due to higher investments and meaningful FCF addition is expected only from 2020-21.
- Buy: 25
- Hold: 1
- Sell: 3
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