Near term challenges for Hindalco

Novelis, the American subsidiary of Hindalco Industries, which is a producer of value-added aluminium products, reported a weak performance for the quarter ending March. Operating earnings (before interest, taxes, depreciation and amortisation, or Ebitda) per tonne was around $265, about a fifth lower than in the March 2014 quarter and 15 per cent lower sequentially.

The inability to pass on costs of earlier metal purchases, that Novelis bought at higher regional premiums, impacted the performance and is likely to cause stress in the coming quarters as well, believe analysts. The decline in aluminium premiums (additional price over and above the benchmark rate), especially in Asia, can benefit in the longer run, enabling Novelis to produce at competitive prices compared to Chinese entities. In the near term, however, it will remain a drag on profitability.

The macro headwinds in terms of demand and adverse currency movement have also hurt profitability of the US business. Though weak demand in the cans business could have been offset to an extent by a high and rising margin portfolio for automotive sales, these were offset by a depreciating euro, declining regional premiums and hot mill outage in North America (a one-off) in the quarter, say analysts at Elara Capital.

The volatility in aluminium prices and realisations due to weak demand across regions, especially from China, has been a concern for aluminium producers. While Novelis has been working on capacities, now 3.6 million tonnes a year, it has also worked on automotive sales, up from five per cent to 11 per cent of revenue in FY15. Besides, re-cycled material (helps lower costs) rose to 49 per cent in FY15 from 33 per cent in FY10.

Yet, profitability remains lumpy. Some quarters earlier, the company was seeing a profitability increase due to rising aluminium premiums but these have sine been falling. Analysts at Elara Capital say Ebitda has actually contracted at a compound annual rate of four per cent (over a five-year period) to $902 million in FY15.