Novelis Hedges Hindalco Against Lme Price Volatility

Novelis hedges Hindalco against LME price volatility

Moneycontrol.com

12th February 2007

The Aditya Birla Group has acquired the entire 100% stake in Atlanta-based aluminium company Novelis for USD 6 billion in an all cash deal. Demerging from global aluminium major Alcan in 2005, Novelis operates in 11 countries and employs 12,500 people.

Managing Director at Hindalco Industries, Debu Bhattacharya believes that the Novelis buy hedges Hindalco against LME price volatility. He further adds that Novelis brings in value-added products and tech support. He also informs the consolidated revenue of the merged entity is seen at USD 13.5-14 billion (proforma). He further states that Novelis' profitability will improve substantially by Jan 2010.

Excerpts from CNBC-TV18's exclusive interview with Debu Bhattacharya:

Q: The market seems to have a few apprehensions about the strategic nature of the move that you have taken. Does it make sense for you to buy a processing company at this end of the cycle?

A: Yes, it does make enormous sense and I will explain why – Hindalco has been primarily the upstream business that is producing alumina and aluminum. We run this business successfully and we have one of the lowest-cost producing units in the world.

However, at the same time, this is exposed to the vagaries of LME. Therefore while the going is good, the profitability will be excellent. But when the LME does come down, it will have certain severe impact on the profitability, which has happened in the past as well. It will happen to the very best in the world, though because of our low cost structure, we will be less affected.

So we have been looking at the possibility of extending it to the value-added product so that we get hedged because that is a value added product business and is, by and large, a complete insulates business from LME. Therefore we have been looking at value-added products and if one would have observed, we were about 43% of the total turnover of Hindalco five years ago and we have been increasing this. We have now come to about 59% in the Q3 of this financial year.

However, there is a limitation as to how much we increase because our total volume around 2,20,000. We do not have the capability or the technology required to get into the premium end of this segment. Therefore, we have been looking at the possibility and evaluating whether we can get something, which will shorten our learning curve and get to the assets and technologies of the high-end products.

One couldn’t get a better target than Novelis, as Novelis is number one in the FRP (flat rolled products) business, which consumes about 40-41% of total aluminum consumed in the world. So the outlet for aluminum is primarily flat rolled product, and in this, Novelis ranks first in the world with 19% market share. Globally too, it is a leader, being number one in Europe, South America and Asia and number two in North America.

Therefore one can see that Novelis straddles between developed market and also the growth market of Asia and South America. Therefore, in my book, based on the detailed due diligence that we have done over the last couple of months by our technical, commercial and finance team, I am convinced that Novelis is, by far, the best target that we can have given.

Q: Can you talk a bit about the financials as well? What sort of combined turnover these two companies will now have?

A: Novelis runs in calendar year terms; '06 results are not published and therefore I would refrain from giving any number for '06 - though I am privy to all the numbers but I cannot quote it.

Their turnover for '05 was about USD 9 billion and currently Hindalco will be about USD 4.5 billion. So Hindalco proforma consolidated will be somewhere around USD 13.5-14 billion and it will grow further as we go along, so it will be a substantial aluminum business by any standard.

Coming to the profitability, Hindalco has done extremely well in this financial year. It had a PAT growth of 92% this quarter over the corresponding quarter last year and I have presented in detail after the quarter was over.

Going back to Novelis, it is going through a bad patch. This patch is not because of any reasons of market or operations but because of a can contract that they are suffering from.

As Pepsi, Coca-Cola and other beverage manufacturers, they buy aluminum cans from can manufacturers; can manufacturers in turn buy the flat roll sheet from companies like Novelis and they supply about 42% of every can that is produced and used in the world.

When these can manufacturers got into contracts, they went for whatever reasons – I am not aware of – there must have been some compulsions of having a can price sealing, which means regardless of whatever the LME is, they will supply can stock at a price not higher than the corresponding price of LME.

So if the LME goes above USD 1,900, Novelis is buying metal at a higher price and subsidizing in the form of fact that it is selling at a price corresponding to no more than USD 1,900 and this because of large can stock contract, it has been a one-time hit. Therefore, the book profit will be significantly lower.

But the good news is that by January 2010, all these contracts will fall off and the profitability will improve substantially. However, I can assure you that operationally, the company is doing well and it is showing substantial improvement YoY.