Metal Of The Future
This blog is on Aluminium Sector and Hindalco Industries Limited. This blog will cover the entire understanding of Aluminium sector, starting from some global data, then Indian sector and then Hindalco as a company.
Disclaimer: This blog is not a recommendation to buy / hold / sell any stock. This blog is mainly for information and educational purpose only. The intention to share write ups on this blog is to create a repository of ideas so that investors / visitors on the website / blog can have a look at various frameworks & approaches. Please read the detailed disclaimer at the bottom of the post.
About Aluminium:
Aluminium (henceforth will be referred to as 'Al') is the second most used metal in the world after steel. Let us start with some basics about Al as follows:
- It is a global commodity.
- The chief ore of Al is bauxite.
- Bauxite makes up about 8% of the Earth's crust, third most abundant element after oxygen and silicon.
- In the 19th century, Al was considered more precious than gold and silver.
- In the last 10 years, Al is growing @ ~6% in the World and 9% in India.
GLOBAL AL
Al Value Chain:
The major process in making Al is Smelting, for which power is the main constituent. Power comprises ~45% of the total cost of production. Bauxite is converted to Alumina and Alumina is then converted to Al.
The sole demand for Alumina comes from Al, hence pricing of Al determines the prices of Alumina. Integrated players make Alumina from bauxite mines and non-integrated players purchase Alumina from outside.
History of Al prices:
Al as a commodity is listed on London Market Exchange (LME) and Shanghai Future Exchange (SHFE) located in China.
Generally, there is a pricing difference of up to $50-$100 in the two stock exchanges on account of the total volume traded on a particular stock exchange.
Most of the countries consider LME prices as the base price for pricing the metal. Now, LME is located in London that price would ideally be the price I would pay if I am taking the delivery in London. But, if I am located in India, then LME price would not incorporate the freight charges, storage charges etc. for bringing the commodity in India.
Hence, every company prices its commodity on LME + Premium. Premium mainly incorporates your freight, storage, insurance, etc. So all the Al trades are undertaken on LME price + Premium pricing, irrespective of what your actual cost of production is, and irrespective of what your holding and what your delivery costs are i.e. LME and Premium prices which are listed, are indicative of rates at which real trades happen.
There are 4 types of premium:
- US Midwest Premium
- MJP (Major Japanese Port)
- Rotterdam; and
- Singapore
Premium are generally traded in the range of $70 - $100.
In India (and other Asian trades), Al is priced at LME + MJP pricing.
The Al prices are very volatile, in 2008 when all the commodities rallied Al touched its peak too (~$3200/tonne) and in 2009 GFC gave away all the gains. In 2016, the dip in the prices came on account of devaluation in the Chinese economy. The year 2018, brought curtailments in China on account of excess carbon emission, this lead to an increase in the prices of Al. Thus, shutdowns are very important as they play a very important role in the pricing (explained later in the blog)
Now that we have understand how Al is traded, lets look at the Global Scenario.
Global Alumina Production:
As seen from the above, China is the largest producer of Alumina (almost 50% of the total production). The growth in Alumina more or less matches the growth in Al.
Now, China imports a large quantity of bauxite from Australia, Guinea and Indonesia to make Al. The bauxite that China possesses is very low quality, hence it has to import.
Indonesia is planning a bauxite ban in 2022. If the ban is implemented, China will then have to import Alumina, which in our view may lead to an increase in prices of Alumina.
Generally, Al price strength is key for alumina as the sole demand for Alumina is Al. Hence, an increase in the price of Al will also impact the pricing of Alumina.
Usually, the Alumina:Al pricing ratio is in the range of 15-20% as depicted below:
Global Al Capacities:
- The global capacities have grew more than 50% in the last decade. In 2018, there were curtailments in China on account of carbon emission norms. China has the highest amount of pollution emission and considering Al is a high power consuming metal, resulted in curtailments.
- There is steep increase in capacities in Bahrain, riding upon low gas costs and eventual low energy costs.
- The aluminium industry is not only growing due to increasing demand for its products but is also in a state of structural transition towards new centers of production, economical energy outlook and new markets.
- India has no plans for expansion in the primary metal due to lack of Govt support to help lift the sector. (shall be discussed in the latter part of the blog)
Global Al Production:
 |
Global Al Utilisation Levels:  |
The above graph depicts the utilisation levels of smelting capacities over the years. During times of peak demand, like in 2008, the utilisation levels had crossed 90%. Post GFC, the utilisation levels dropped to 75% and with some curtailments over last few years, and with demand coming back, the utilisation levels are now at 84%.
Why Al as a Sector:
- Growing demand for Al and Al Value Added Products (VAP)
- Strict CO2 norms - Use of Al reduces the weight of the vehicle and increases fuel efficiency
- Replacement to plastic which reduces GHG emission
- Electric cars demand more Al proportion in its body
- Reduction of wood in construction
- Al will also play a critical role in renewable energy setup like wind, solar and energy storage batteries.
- Shipbuilding can add big volumes
Al vs Steel:
Al is often looked at, as a substitute for steel. We list down few points where Al can find new demand points:
- Light Weight - Steel is typically 2.5 times denser than Al
- Corrosion Resistance - Al doesn’t rust unlike steel
- Strength & Malleability - Al is a very desirable metal because it is more malleable and elastic than steel
- Cost - Steel is generally cheaper than Al. Steel - $490/tonne and Aluminium - $1600/tonne
- Recyclability
Problems in the Sector - Globally:
- Oversupplied. Utilization levels dropped from 90%+ to mid-80’s
- Expensive metal in comparison to steel
- Absence of reforms in power / energy, beyond coal
- Presence of speculation leading to volatility
- Not as mature as steel
- China receives export incentives on Al VAP
- Upcoming new low cost smelting capacities (based on gas, hydro power) in China and Middle East
China, does not make the cheapest Al (will explain later in the blog), but the Govt in China provides stimulus to the Al players making it viable for them to sell the Al at the low rates without going bust.
The Glorious Past:
In 2007, on account of the vast spread in the cost and LME, the EBITDA per tonne went up to $950/tonne.
The next two paragraphs on global cost curves are the most important part of the entire blog.
Alumina Cost Curve (as on May'2020):
A cost curve depicts cost of each and every capacity (globally), and how many capacities are under water or no. For instance, 20,000 tonnes capacity operate in the 1st / top quartile i.e low cost producers. The capacities below the blue line, are making money at the prevailing Alumina price. As you can see, maximum Chinese capacities come under the last and second last quartile of the cost, making them the most in-competitive Alumina producers in the world.
In the above graph, as we see ~50% of the capacities are above the cost curve i.e. ~50% players are making losses whose cash cost is above $220/tonne.
Further, if you look at the graph closely, the cost curve have fallen from 2019. In 2019, only ~25% capacities were viable at $220.
Now how does this impact our analysis, when capacities make losses on production then two questions arise whether to produce at losses or shut down. Now shutting down a capacity comes with hefty cost hence, it depends on the financial capability of the Alumina producer for how long they can sustain. Such situations may or may not lead to curtailments based on the financial strength of Alumina Producers.
In addition to the above, we believe that in such scenarios where 25% of the Alumina players are making losses this is an indication that the Alumina market prices have entered a low in its cycle. A case where 50% of the players are making loss, is far more stressfull scenario, and probably the best entry points. Hence, this chart is extremely important for analysing the stage of Alumina cycle.
Indian capacities are in the top quartile of the cost curve and hence can survive the ups and down in Alumina cycle.
Al Cost Curve (as on May'2020):
On the same lines as Alumina cost curve, at $1500/tonne Al prices approximately 25% of the smelters were making losses. If I compare the $1500/tonne price in 2019, only 7% of the Al players were financially viable. (in Dec-2015 quarter, when there was a low in commodities across, the cost curve then showed that 75% of the Al producers were making losses)
The Al LME prices have bounced back strongly in last 2 months mainly on China demand coming back.
To enter a commodity cycle it is very important to enter at the bottom of the cycle to earn maximum gains. To enter or time low in the cycle, wait for 25% producers making losses. You will get this scenario once in 2-3 years.
World Ex-China Curtailments:
In the above graph, we have tried to explain how curtailments have occurred during recessions over the years and what can happen in the current scenario.
China Curtailments:
Generally, there are NO curtailments which come for Chinese smelters during the times of stress; they somehow get incentives and sustain the down tick. Recently, there was news Chalco (Aluminium Corporation of China Ltd) shutting 1.8 MT of Alumina capacity roughly around 2nd July, 2020. One can check the movement in the prices post the announcement.
Types of Al Metal In The Market:
1. Primary Metal - 1st hand
2. Secondary Metal - Recycled
3. Value added products (VAP) - cans, foils, extrusions, casting etc.
Major Players And Their Integration:
In India, Hindalco is present across all the three process.
After, understanding the Global Scenario lets look at India.
INDIA
Indian Al Sector Facts:
- Indian Al producers are among low cost producers
- Backward integration (bauxite and coal mines)
- India faces problems from cheap and fake aluminum products
- No MIP on Al
- Import duty was increased from 5 to 7.5% in the current budget
- Consumption ~4mn tonne (FY20) as under:
- 4mn tonnes production
- 2mn tonnes imports
- 2mn tonnes exports
- Domestic Play
- Capacity utilization will soon reach optimum levels from present 84%
- No meaningful capacity additions over next 5 years
- Patchy coal availability and pricing resulting into higher costs
- Energy, mining and infrastructure is still patchy in Indian Al value chain
- Possible growth in demand in VAP
Indian Alumina and Al Capacities:
In our blog we are going to mention about Hindalco Industries.
HINDALCO INDUSTRIES LIMITED
About Hindalco:
Below in our brief summary on Hindalco:
- Integrated Al plant with converter facilities
- Among lowest cost producer of Alumina
- Among lowest cost producer of Al
- Strong & predictable downstream with Novelis & Aleris
- 65-70% of EBITDA is LME de-linkined
- Shift from a commodity to VAP company
- Deleveraging play
- Best in Indian Al sector
- Last man standing
Last Decade Journey:
Hindalco Assets:
- Alumina
- 3 MT
- Aluminium
- 1.28 MT
- India VAP
- 0.36 MT
- Copper
- CC Rods, Cathode, DAP
- Novelis VAP
- 3.5 MT
- Aleris
- 1 MT
HINDALCO STANDALONE + UTKAL
Cost Break up of Al:
The main cost in Al is power therefore the power sourcing of any company is very important to ensure that they are making the metal at low cost, other RM cost includes caustic soda, coke pitch etc.
Hindalco is a fully integrated company. It has its own bauxite mines, procures its alumina requirements from Utkal, Renukoot and Muri, makes Al and VAP products too.
Below mentioned are some of the facts on Hindalco:
- Utkal (Hindalco's subsidiary) is one of the lowest cost producers of Alumina in the world (lesser than NALCO too)
- Power is the main cost i.e. approx. 45% for making Al
- Mahan and Aditya are the latest and cost efficient Al smelting plants
- Coal requirements:
- 60% linkage (cheapest source)
- 35% e-auction
- 2% from captive mine
- 3% from imports
Alumina – Lowest Cost Producer:
In the above graph it can be clearly seen that Utkal is at the start of the Alumina cost curve making it one of the cheapest Alumina producer in the world; Muri too is in early percentile range but Renukoot is expensive, but cumulatively all three put Hindalco in the 1st quartile of the cost curve.
- Utkal produces approx. 1.5 MT of Alumina
- Utkal ramp up from 1.5 MT to 2 MT has started and shall commission by 2022 leading to further lower cost of Alumina
Hindalco doesn't plan to shut down its Renukoot facilty once Utkal ramps up, but plans to keep as an insurance for over concentrated and over dependent Utkal facility.
Hindalco Hedging Strategy:
- Partly
hedging of the following based on view / opportunity:
- Key
RM
- Al
(38% of FY21 volumes are hedged at $1732/tonne; some volumes in INR)
- Currency
- Premiums
are not hedged
- Novelis
is 100% (other than premiums) hedged since it is a pass through
- Movements
in copper are a pass through
- Hedging
leads to predictability of cash flows
Al India Performance:
In the above graph, one can observe that even at low LME + Premium prices, Hindalco has made a good EBITDA per tonne. Hindalco survived the recent Dec 2015 stress too, with decent numbers.
When it comes to a commodity play, the most vital element is cost and the lowest cost producer will survive to say the tale.
NOVELIS
Novelis Shipment Mix:
The major business of Novelis comes from "Can" segment. The Can segment is low margin business but a resilient one. The Can market has showed resilience towards pandemic and has not suffered much.
Auto, Aerospace etc are high margin businesses. When Hindalco acquired Novelis back in 2007, it only was into Can business. Over the years, Hindalco introduced the auto segment to the business and specialties making it one of the big players in the industry.
For any VAP company the best way to increase the margins is by changing the product mix. Novelis had recently made news on its acquisition of "Aleris". It is estimated that together Hindalco + Novelis + Aleris will make up 15% of the Al space globally.
Expected Product Mix Post Aleris:
- Through Aleris, Novelis gets into aerospace, automotive, and specialty products (marine and electronics).
- Novelis will get $150mn synergies
- Is acquisition of Aleris at wrong time? Time will tell
What makes Novelis a strong player:
More than 60% of the metal used by Novelis is recycled scrap. Using of recycled metal generate higher EBITDA as the same costs lower than LME Al. Recycling spreads increase during bull market and vice-versa.
Novelis Performance over the years:
Novelis has seen growth in its EBITDA/tonne over the years. From ~$300/tonne to $450/tonne mainly on account of increasing recycled input and change in sales mix. Novelis alone contributes approx 65% of the EBITDA of Hindalco (Group).
Novelis is a very important leg of Hindalco.
Aleris Synergies:
- Access to global aerospace clients - Hindalco-Novelis has access to the niche aerospace market with technological capabilities in manufacturing and research and development in the Aleris facility in Koblenz, Germany. It enhances its value-addition growth prospects to further strengthen its presence among blue-chip clients such as Airbus, Boeing, Bombardier, Denso, Dana, Comac, etc., with which Aleris has secured long-term contracts.
- China auto sheet business - Aleris also has operations in Asia, which will be a consolidated entity. This strengthens the ability to serve the automotive demand, especially for auto sheets, at a higher scale in China. Aleris commissioned the Zhenjiang facility, situated close to the Hindalco-Novelis facility in Changzhou, and announced the decision to double its capacity to 200 KT per year.
- Consolidating its position in the US market - Further strengthen its presence in the FRP segment with a cost-effective and streamlined business and access to a larger customer base. In the specialty electronics segment, Aleris has plants in Lincolnshire, Ill., Lewisport, Ky., Uhrichsville, Ohio, and Clayton, N.J., which Hindalco-Novelis will now have access to, making it the largest producer of FRP electronics in North America. This will ensure that Novelis-Aleris is a strong competitor alongside Arconic.
- Heat exchanger segment in Europe - This is a crucial segment for Aleris as it is linked closely to the automotive sector and will strengthen Hindalco-Novelis-Aleris’ footprint across Europe.
- Marine plates business (specialty) - Hindalco-Novelis can capitalize on its marine plates business, which currently focuses on North America and has applications in cruise ships, boats, LNG carriers, etc. Novelis gained access to the European customer base with Aleris plants in Germany (Koblenz).
Currently, Novelis has to divest Aleris Duffel, Belgium (US$340mn by Liberty group, subject to China approval) and Lewisport, US facilities (timeline yet to be discussed with US DoJ- may take around 9-12 months).
Snapshot of Copper business:
Hindalco is a copper smelter and not into mining. Tc/Rc margins matter to it, while it does not have any exposure to fluctuations in price of copper.
Hindalco’s EBITDA from the copper segment consists of:
- Tc/Rc Margins – 50% contribution
- VAP and Premiums – 25% contribution; and
- Sale of by product like sulfuric acid and DAP – 25% contributions
The margins in VAP are higher, thus Hindalco has recently commissioned a 235KT copper rod value‐addition plant. This would help to increase value‐ added products, which command US$ 200/tonne better premiums than copper cathodes.
Further, on the volume front, Hindalco shut down its copper smelters during Apr’20, but has restarted one smelter in May’20. However, we do not expect Hindalco to make up for the lost volumes in FY21 due to frequent smelter breakdowns.
EBITDA Breakup:
- Indian Al
- 38% hedged at $1732/tonne; don’t know if front ended or back ended
- 62% on spot which is LME linked
- Copper
- 100% LME Delinked
- Novelis
- Al LME price fluctuations in Novelis is 100% pass through
- Recycling spreads though affect the EBITDA
- Overall ~65-70% of EBITDA is LME delinked
Hindalco Financials:
Income Statement:
Balance Sheet:
Cash Flow:
Ratios:
Snapshot
This was our analysis of the company and the sector. Now, lets take a look on stock prices of the stock.
Hindalco stock performance:
The stock has been range bound since the last 15 years which signifies that this is not a 'buy and hold' stock but is a 'buy at low and exit at top' stock. Th stock may not have moved, but our job is to understand whether the stock is a value trap or is it really a growing company with "value" attached.
Historic Valuations:
As we can see, present valuations (as on May'20) are near the lows in the last 10 years.
LME Play?:
This chart shows the movement of the stock closely tracks LME Al prices. While we know that ~65-70% of its EBITDA is LME de-linked, it means that when the stock over reacts to a crash in LME prices, it seems to be an "arbitrage" play. But as depicted above, the stock is somehow tracking LME and we should try to bottom fish when LME crashes.
Bottoming of LME prices (or more-so the spreads) happen basis the global cost curve. Hence analysis of spreads (taking care of inputs too) along with cost curve helps us clearly understand which part of the cycle we are in.
Conclusion / Summary:
From the above blog, we try to summarize our understanding of the sector and Hindalco as a stock:
- The sector is a growing sector (not a sunset sector)
- Sector, like any other cyclical sector, is NOT a BUY-&-HOLD sector
- If timed properly, can help gain very good returns (at the same time, if timed incorrectly can put you in trouble or mis-investment)
- In any cyclical play, it is important to invest in a "Last Man Standing" company, because cost effectiveness is the key to survival
- Analysing global cost curve is crucial
- Integrated player + Low valuations
- Shift from a commodity company towards a VAP company, over a long period of time
Source of the data:
Some of the data used in this blog is created by Centra, while some data may have been fetched through various websites, content, files, brokerage house notes, etc. available freely on the social media.
Disclosure:
The information herein is used as per the available sources of exchanges, company’s annual reports & other public database sources. Centra Advisors is not responsible for any discrepancy in the above-mentioned data. Investors and readers of this blog should seek advice of their independent financial advisor prior to taking any investment decision based on this blog or for any necessary explanation of its contents. The blog is based on personal opinions & views of the author. Readers are responsible for all outcomes arising of buying / selling of particular scrip / scrips mentioned here in. This report indicates opinion of the author & is NOT A RECOMMENDATION to buy or sell securities. Centra Advisors & its representatives may or may not have any vested interest in above mentioned securities at the time of this publication. Centra Advisors, or it’s associates are not paid or compensated at any point of time, or in last 12 months by any way from the companies mentioned in the report. The views expressed in this post accurately reflect the authors personal views about any and all of the subject securities or issuers; and no part of the compensations, if any was, is or will be, directly or indirectly, related to the specific recommendation or views expressed in the report.
