Indian Aluminium Industry

Background

The Indian aluminium sector is characterised by large integrated players like Hindalcoand National Aluminium Company (Nalco). The other producers of primary aluminiuminclude Indian Aluminium (Indal), now merged with Hindalco, Bharat Aluminium (Balco)and Madras Aluminium (Malco) the erstwhile PSUs, which have been acquired by SterliteIndustries. Consequently, there are only three main primary metal producers in the sectornamely Balco (Vedanta), National Aluminium Company (Nalco) and Hindalco (Aditya BirlaGroup).HistoryAluminium production in India commenced in 1938 with the commissioning of Aluminium Corporation of India's (Indal) plant in technical and financial collaboration withAlcan, Canada having a capacity of 2,500 ton per annum. The plant started with sheetproduction using imported aluminium ingots.

In the 1970s, the government regulated and controlled the aluminium industry throughprice distribution controls and barriers to entry. The 1970 Aluminium Control Ordercompelled the Indian companies to sell 50 % of the aluminium produced for electricalpurposes.

The government decontrolled the industry in 1989 with the removal of the AluminiumControl Order. The industry was de-licensed in 1991 and was allowed liberal import ofcapital goods and technologies.

The demand for aluminium grew 6 % in the 1980. Aluminium demand postliberalization registered a growth rate of 12%. This coupled with the increase in the globalaluminium prices ($1800/ ton in 1994) led to increased investments in this sector.

The downstream capacity in the aluminium industry spurted due to sufficient dutydifferential between aluminium ingots or primary metal and value added downstreamproducts. In March 1993 while the duty on aluminium ingots was 25% the duty ondownstream products was 70%. However with the change in the tariff structure undertaken inthe 1997 budget, duty on semi-fabricated metal was lowered to 25%. This change adverselyaffected the fortunes of the downstream producers.

Features of Indian Aluminium Industry • Highly concentrated industry with only five primary plants in the country. • Controlled by two private groups and one public sector unit. • Bayer-Hall-Heroult technology used by all producers. • Electricity, coal and furnace oil are primary energy inputs. • All plants have their own captive power units for cheaper and un-interrupted power

supply. • Energy cost is 40% of manufacturing cost for metal and 30% for rolled products. • Plants have set internal target of 1 – 2% reduction in specific energy consumption in

the next 5 – 8 years. • Energy management is a critical focus in all the plants.

• Two plants have declared formal energy policy. Each plant has an Energy Management Cell

Indian Aluminium Industry is an Oligopoly:-

The reasons for the aluminium industry to be an oligopoly is

• Economies of Scale. The major input in producing primary aluminium is alumina and power which

constitute about70% of the cost in producing. Although the requirement of alumina does not vary much with the size of the plant but the consumption of power varies drastically. Hencewith higher production capacity the cost of production goes down. For a new playerproducing aluminium and low cost will be very difficult.

• Huge capital investments. The capital required to setup an aluminium production plant is huge. E.g.: BALCO spent about $1 billion to set up a 2.45 lakh ton capacity with 540MW power plant. • Time to setup.

It requires around 3 years to setup a plant of the size mentioned in the above example. The new player would require about 3 years to start manufacture primary aluminium and the market demand supply equation can change by the time the firm starts manufacturing.

• Control over the Bauxite mines.

As the raw material for manufacturing aluminium is bauxite the existing players have control

over the bauxite mines in India and it would be difficult for a new player to get new bauxite mines.

• Scarcity of power. About 30-40% of the cost of producing is power. As producing primary Aluminium requires a large amount of electricity they need to have captive power plants. Setting up of captive power plants requires huge capital investment and also requires a lot of time. The basic raw material to generate power is coal. Hence the firms also would need to have coal mines. Most of the coal blocks are owned by independent power producers and hence the coal blocks are scarce.

• Government Factor. The other major hurdles are getting environmental clearance from the government. The other

factor would be in getting bauxite mines allotted to the firm. Hence in these two cases the government acts as a barrier.

• Land.

Existing players can expand as setting up a new brown field project is easy than getting land allocated for a new green field project considering the political situations in India.

• Geographical factors.

The bauxite ore is abundant only in the states like Orissa and hence the firms entering into the market need to setup the plant in these states.

Consumption The consumption of primary aluminium has risen sharply since 2002 and reached 1,080 KT by

2006. From the end of the 1990s till 2002, the consumption remained almost stagnant, around 500- 600 KT. The reason for this growth after 2002 lies in the demand generated from automobile, construction and packaging sectors.

The per capita consumption of aluminium in India continues to remain abysmally lowat under 1 kg as against nearly 25 to 30 kgs in the US and Europe, 15 kgs in Japan, 10 kgs inTaiwan and 3 kgs in China. The key consumer industries in India are power, transportation,consumer durables, packaging and construction. Of this, power is the biggest consumer(about 44% of total) followed by infrastructure (17%) and transportation (about 10% to 12%).However, internationally, the pattern of consumption is in favour of transportation, primarilydue to large-scale aluminium consumption by the aviation space

Challenges Ahead 1.A long-term decline in the real price of Aluminium will erode margins of the firms manufacturing primary aluminium. 2.Pressures to improve return on investment.

3.Maturing of terminal markets such as the London Metals Exchange (LME) as the firms are price takers and have little scope to decide the price.

4.Technological changes — particularly on the upstream side. There has been no alternate method developed to extract metal from the ore. 5.Intense competition from other materials such as steel and plastics which are the substitutes to aluminium.

6.Need to respond to the changing demands of global customers, such as automakers and can manufacturers.

7.Reduce the consumption of electricity consumed in producing aluminium i.e. increase the energy efficiency.

8.Reducing the greenhouse gas emissions and PFC from the production process.

C.A.P.M & Risk and Return Approach:-

In the project, Cost of Equity was calculated using the C.A.P.M model.

As per C.A.P.M model:-

Ke = Rf+ β (Rm-Rf)

Where,

Ke = Cost of equity

Rf = Risk free rate

Β = Beta

Rm-Rf = Equity market risk premium

Risk free rate- This is the amount that investors get by investing in risk free investments such as government bonds

Beta- Beta- This measures how much the company’s share price moves against the market as a whole.

Beta of 1 indicates that the company moves in line with the market Beta>1 indicates the share is exaggerating the market’s movement Beta <1 indicates share is more stable Negative Beta indicates that the share prices move in the opposite direction of the broader

market.

Equity market risk premium – This represents the returns that the investors expect over and above the risk free rate for taking the extra risk and investing in equity.

Beta of all the companies is as follows:-

Beta Of CompaniesHINDALCO NALCO HIND Al Alumeco Extrusion Boruka Al Parekh Al

0.45 -1.37 0.32 0.45 -0.02 1.54

Conclusion:- 1. Beta of Parekh Al is 1.54 which means that the company share is

exaggerating the market’s movement.2. Beta Alumeco Extrusion, HIND Al, HINDALCO is 0.45, 0.32, 0.45 respectively

which means that share is more stable.3. Beta of Boruka Al, NALCO is -0.02,-1.37 respectively which means that share

prices move in the opposite direction of the broader market.

Graphical Representation of Beta of all the companies:-

HINDALCO NALCO HIND Al Alumeco Extrusion Boruka Al Parekh Al

2.00

1.50

1.00

0.50

0.00

0.50

1.00

1.50

2.00

0.45

1.37

0.32 0.45

0.02

1.54

Beta Of Portfolio

Companies

Beta

W.A.C.C. Approach:-

Weighted Average Cost of Capital is the calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk.

W.A.C.C. of all the companies is as follows:-

Weighted Average Cost Of capitalHINDALCO NALCO HIND Al Alumeco Extrusion Boruka Al Parekh Al

9.64% -4.83% 1.65% 11.88% 13.05% 8.51%

Conclusion:- W.A.C.C. of Boruka is the highest which means that it is the most risky company of the group while that of NALCO is the least which means that it is the least risky company in the group.

W.A.C.C. of Boruka Al>Alumeco Extrusion> HINDALCO> Parekh Al> HIND Al> NALCO.

Graphical Comparison of W.A.C.C. of all the companies:-

HINDALCO NALCO HIND Al Alumeco Ex-trusion

Boruka Al Parekh Al

2.00

1.50

1.00

0.50

0.00

0.50

1.00

1.50

2.00

0.45

1.37

0.32 0.45

0.02

1.54

W.A.C.C

Companies

WAC

C