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Is coal sourcing putting Hindalco’s cost competitiveness under threat?

Firm has been forced to procure coal via imports, e-auctions after it lost allocated mines after SC order on coal block allocations

Hindalco Industries Ltd will likely face higher production costs as the aluminium producer is forced to source coal via imports, e-auctions and eventually mines that are located at a greater distance from its smelter compared with the mines its lost after a Supreme Court order last year.

The company’s average cost of production, which was among the lowest at Rs.1,700 per tonne prior to the cancellations, is set to go up materially, analysts say.

Coal and power typically make up 35% of its production costs. It is difficult to assess the actual increase in costs at the current juncture given that the company is yet to sew up new coal sources. On 24 September, the allocation of four coal blocks to Hindalco—Mahan, Tubed, Talabira-I and Talabira-II—was cancelled after the Supreme Court ruled that the government had followed a flawed process in allocating more than 200 mines between 1993 and 2010. Since each of these blocks has now been reserved for regulated sectors, Hindalco will need to bid for different mines, all of which are located at a greater distance.
According to a 23 December report by brokerage Antique Stock Broking Ltd, all the alternative coal blocks available to Hindalco are located at a distance of between 100km and 700km from its existing smelters in Madhya Pradesh and Odisha, which will push up logistic costs. “Hindalco would have to bid for alternative coal blocks considering the size of coal reserves and logistic cost, based upon the distance from the coal mines and rail connectivity. Logistics costs are likely to be incrementally higher as compared to the earlier captive coal blocks, which were closer to smelters,” the report said.

Other analysts agreed that fresh sources of coal will come at a higher cost. Every additional 100km of transportation of coal through rail or road could roughly increase the cost of coal by an additional Rs.500-1,000 per tonne depending on the mode of transport, said three other analysts Mint spoke to who declined to be named. Hindalco did not reply to an mail sent on Thursday as the company is in the so-called silent period ahead of declaring its quarterly results. While the long-term cost of sourcing coal will be determined only once new mines are allotted to the company as part of the auctions scheduled in February, the company has already taken a temporary hit as it sources coal via imports and e-auctions. For an aluminium company with captive capacity, each tonne of coal costs between Rs.900 and Rs.1,000 per tonne, while imports cost Rs.3,500 per tonne and coal bought from e-auctions costs roughly around Rs.2,000 per tonne.

Therefore, coal sourced from external sources incrementally increases the cost of production further, said one of the three analysts quoted above. Analysts are also concerned that the firm will remain reliant on external sources of coal in the near term as a ramp-up of production from any new mines allocated to it will take time. “Owing to the SC verdict, Hindalco lost control of one operating and three allocated coal mines, which were expected to meet more than 50% of its eventual coal needs of ~17MTPA.

Even in case of an immediate auction and quick approval for new coal blocks, mine commissioning and production ramp-up could take 3-4 years,” said a 23 December report by Reliance Securities Ltd. The report added that the likelihood that Coal India Ltd will bring down the quantum of e-auction sales to 7% of its total shipments from fiscal 2015 onwards compared with close to 11% in fiscal 2014, will mean that the proportion of imported coal in the company’s raw material mix will rise. “This step will curtail e-auction volumes from close to 60 million tonnes (mt) in fiscal 2014 to almost 30mt, going forward.

Consequently, coal available to non-power consumers will reduce. Hence, production costs could increase more than our estimates, going forward,” said the report, noting that Hindalco’s cost of production will be higher than earlier estimated. A second analyst quoted above said that while coal sourcing costs may increase, the company still will maintain a competitive advantage due to its reserves of bauxite—the raw material from which aluminium is made.

“Hindalco has been operating the Renukoot smelter in Odisha for the last several years without a coal mine and has still managed to maintain an average production cost of Rs.1,700 per tonne, which is commendable,” said the analyst from a domestic brokerage. “With bauxite reserves of 440 mt, Hindalco’s reserves are sufficient to meet its expanded capacity. Also, with imported coal prices coming down in the last few months, Hindalco will have a cushion in terms of containing the cost of production,” he said, adding that all negatives in terms of increasing cost of production had already been factored in the company’s stock price.

Since the firm’s coal blocks were cancelled on 24 September, Hindalco’s share price has fallen by 23.54%, from Rs.197.55 per share to Rs.151.05 per share as on 12 January. The stock has recovered from the low of Rs.144.7 per share hit on 16 December. While the company’s cost of production may rise in fiscal year 2015 and beyond, Hindalco will see strong growth in volumes, said Reliance Securities. “...with Mahan and Aditya ramping up, Hindalco’s standalone aluminium sales will increase by 37% in fiscal 2015 to 840,000 tonnes and volumes will gradually increase to 1.2 mn tonnes in fiscal 2017, translating into a compounded annual growth rate (CAGR) of 25.3% over fiscal 2014-2017,” said the report.

Now, the company has a capacity to produce 1.2 million tonnes of aluminium per annum, which requires a captive power capacity of 2,200 megawatts (MW) and coal linkages of 17 million tonnes per annum.

Source: www.livemint.com