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Identifying an aluminium stock: Do's and don'ts
January 05, 2005

Investing in commodity stocks is always a risky proposition because the cyclicality of the sector is one of the most important criteria, which decides the fate of your investments.

Keeping this in mind, we have tried to highlight here some factors one should keep in mind before investing in an aluminium company.

The biggest trait of the aluminium industry, being a commodity, is the cyclicality of the industry, wherein there are periodic ups and downs. That said, when compared with cement and steel, aluminium is a value-add commodity.

It is a highly capital intensive sector (Rs 200 bn required for a 1 million tonne greenfield capacity expansion). Cost efficiency plays a critical role in the survival of a company in the sector for which, control over inputs (say raw material) is of utmost importance.

Fortunately, the advantage of having the 5th largest bauxite reserves in the world coupled with cheap and abundant labour helps the Indian companies to retain the distinction of being the lowest cost producers in the world.

Globally, the industry is less fragmented when compared with steel and cement.

On basis of scale of operations and level of integration, aluminium producers can be categorized into the following two types:

  1. Integrated producers/Primary producers: Integrated producers have presence right from the mining of bauxite (raw material) to producing aluminium ingots (finished product). Some companies may even go a step further and have downstream manufacturing facilities such as manufacturing of semi-fabricated products (foils). Primary producers could either be a company that is just into mining of bauxite and alumina production or pure aluminium ingot manufacturing. For companies, which have restricted themselves from venturing into the downstream segment, the user industries are basically the secondary producers.

  2. Secondary producers: For this segment of producers, which are involved in the production of semi-fabricated products, the raw material is acquired from primary producers, which is in the form of aluminium ingots and billets. The user industries for this segment would be the packaging industry (foils), auto ancillary (wheels), to name a few.

Aluminium products can be classified under three categories. Rolled products find applications in automobiles, consumer durable, construction and engineering sectors. Extrusions include bars, pipes and tubes that find usage in the electrical and the transportation sectors. Finally, foils are used in the packaging sector, which are high-value products and have higher margins.

Now let us proceed with the various parameters indicated in the flowchart above:


Revenues = Volumes * Realisations

Let's look at the volumes side first.

Growth prospects of the aluminium industry are a function of economic growth. In the Indian context, economic slowdown does influence the demand for aluminium, as its user industries like infrastructure, transportation, consumer durables and housing get affected.

It must be noted that the consumption pattern of aluminium in India is tilted largely in favour of power and electricity (over 1/3rd of total consumption), as against the world consumption pattern, wherein transportation, especially airlines, have a major role to play.

Whenever there is an economic slowdown, demand is affected in these sectors that in turn impact aluminium sales.

The key application of aluminium across sectors is in products like power transformers, railways, auto industry (components and body building), housing (furnishing), packaging (competition is from tin and plastic) and consumer durable sector (body parts).

Investors could gauge potential for aluminium demand based on the aforesaid user industries.

Other user industries

The industry is also looking at increasing volume sales by presenting itself to the steel-user industries as a good substitute option on the basis of its qualities of strength and lesser weight.

This could be a potential opportunity for aluminum, as user industries like auto, could switch to aluminium. Globally, this is a growing trend in the developed economies.

On the domestic front, protection from competition is in the form of tariffs, which makes the landed cost of aluminium into the country comparatively expensive vis-�-vis the domestic produce. Investors have to keep in mind that when customs duty falls, threat of imports increases unless domestic producers are competitive.

Some factors, which determine the realisations for the company, are:

As pointed above, in the face of increasing competition, survival would depend on cost efficiency, more so given the commodity nature of the business. Some of the key expense heads pertain to raw material, power, employees and interest cost.

Since raw material and power constitute over 50% of the total operating expenses, companies with captive facilities have an added advantage. Employee expense is the next big contributor with a share of 12%-15% of the total operating expenses.

If the company has presence in mining, employee requirements tend to be on the higher side. Freight is another important cost, which is dependent on the company's proximity to the raw material source and also to customers.

Finally, as aluminium companies are capital-intensive in nature and have significant exposure to debt, managing interest cost is of utmost importance.

Key parameters to be kept in mind while investing in an aluminium company:

To sum it up, large integrated companies with significant economies of scale and high cost efficiencies with presence in international markets and valued added products are the best positioned to capitalize on any increase in demand for the metal.

This is part of Equitymaster's Reflections 2004 series. is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.

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