Good move for Hindalco, but valuations remain high

Metals company Hindalco Industries Ltd is the latest Indian firm to take advantage of surplus liquidity in the market. According to news reports, it has raised $600 million (Rs2,796 crore) through a qualified institutional placement (QIP). Hindalco trades close to its 52-week high, so from the company’s point of view it has got top dollar for its shares, although the shares were sold at a marginal discount. It’s difficult to understand, however, investors’ willingness to invest at such high valuations. While it’s true the rise in aluminium prices this year has surprised investors, Hindalco’s valuations more than capture this upside. According to an analyst with a foreign brokerage who did not want to be identified, the company gets an enterprise value/Ebitda (earnings before interest, taxes, depreciation and amortization) valuation of eight-nine times based on estimated earnings for the year to March 2011, which is rather high for a firm highly dependent on commodity prices. Of course, based on earnings estimates of some other brokers, the valuations look lower at around seven times, but according to this analyst, these involve aggressive earnings estimates that don’t factor in execution risk, on the one hand, and assume rosy projections of aluminium prices, on the other. Graphics: Naveen Kumar Saini / Mint So far this year, bearish projections about aluminium prices have been proven wrong. Prices have risen by at least 55% to around $2,000 per tonne as China turned a large importer of the metal from being a large exporter last year. Also, large chunks of the supposedly high inventory was locked-up by investors and wasn’t available in the market, leading to a better-than-expected supply situation. But share prices of firms such as Hindalco suggest investors now assume aluminium prices will continue to rise. Besides, Hindalco has large expansion plans that involve an expenditure of Rs25,000 crore till 2012. This entails execution risk, which again seems to be ignored. The QIP issue, meanwhile, will help the company reduce leverage. It currently has a net debt of about Rs21,000 crore and a debt-equity ratio of 1.1 times. This will come down to around 0.8. But then financing has ceased to be a concern for Hindalco, given the easing of the liquidity situation, and it’s not like investors are going to breathe a huge sigh of relief. And raising equity at current valuations is good for the firm, as it entails relatively lower dilution.