Birla proves a point with Novelis turnaround story
Monday, Nov 09, 2009
MUMBAI: Aditya Birla group chairman Kumar Mangalam Birla had more than one reason to smile when Novelis, a Canadian firm he bought in 2007 for $6 million, staged a turnaround in the September quarter to post a net profit of $195 million (about Rs 915 crore). The feat by the Atlanta-based firm must have been a personal victory for Mr Birla, who faced criticism from several quarters for backing the deal that was considered expensive. Shares of Hindalco — Novelis was acquired by the Birla flagship — had fallen by 14% on February 12, 2007, the day the deal was announced.
As the turnaround was achieved on the back of strong sales in Asia and South America, the company’s earnings, that will be boosted by tough cost-cutting measures and the closure of loss-making supply contracts, can only improve with the US economy riding out of recession with a 3.5% growth in gross domestic product.
“When you look at the situation and see the EBITDA (operating profit), you know that the performance will only get better and it’s not a flash-in-the pan,” Novelis vice-chairman Debu Bhattacharya told ET. In the September quarter, the EBITDA went up to $200 million from $124 million in the previous quarter and $89 million last year.
Back in 2007, when the group was trying to close the deal, the viability of acquiring a downstream company at a time when the whole world was going upstream was questioned. In the metals sector, downstream implies value-added, high-tech products, while upstream means mining. The company was bought at the peak of a commodities boom when prices of metals, such as copper and aluminium, were ruling at record high levels, almost double the prices seen in the year before. That was the time when the world’s largest metals firms, such as BHP Biliton, Rio Tinto, Xstrata and Vedanta, were on an acquisition spree.
“It was felt that acquiring a company (Novelis) that had about $3.5 billion in debt and had also got locked into a supply contract, was commercially unviable as it would have nullified any metal price upside,” said a senior executive of the group.
Novelis had a can price sealing contract with Pepsi and Coke that restricted the company from selling can stock metal used in beverage cans at a price not higher than the corresponding price on the London Metal Exchange. So, when the price of aluminium surged by more than 60% in the subsequent period, Novelis was buying at a higher price and selling its products to Pepsi and Coke at a lower price. The can contracts will expire on December 31, 2009.
Mr Birla also faced opposition from some senior executives within the group who wanted the greenfield projects to be given priority. Subsequently, the group did both — acquired Novelis, and also went ahead with the greenfield projects in Orissa, Jharkhand and Madhya Pradesh. “But no one anticipated the slowdown that gripped the world and then, access to credit was restricted,” the executive said. Also, in 2008, Hindalco took a $982 million foreign currency loan at Libor plus 315 basis points to pay back a $3.03-billion bridge loan it had taken a year back at Libor plus 80 basis points to fund the deal.
Analysts back the Canadian firm to do well in the coming quarters. “Operational improvements are driving significantly improved profitability in Novelis,” said Promeet Ghosh of DSP Merrill Lynch. Other analysts back this view as the turnaround was achieved at a time when markets haven’t been robust and recovery was just beginning. “This clearly signals that the company has staged a turnaround and the momentum is likely to sustain over the next few quarters,” said a Mumbai-based analyst, adding, “However, the next quarter could see strain on the profitability due to the winter season where the demand for aluminium cans typically fall.” The feat by Novelis is commendable considering cross-border acquisitions by Indian companies have run into hurdles, mainly due to issues relating to integration and developing synergies. Most of their issues on synergy between the Indian company and the foreign company have been market related.