Equity Master Sector Report Aluminium

8/3/2019 Equity Master Sector Report Aluminium

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Aluminium

The most commercially mined aluminium ore is bauxite, as it has the highestcontent of the base metal. The primary aluminium production process consists ofthree stages. First is mining of bauxite, followed by refining of bauxite to aluminaand finally smelting of alumina to aluminium. India has the fifth largest bauxite

reserves with deposits of about 3 bn tonnes or 5% of world deposits. India'sshare in world aluminium capacity rests at about 3%. Production of 1 tonne ofaluminium requires 2 tonnes of alumina while production of 1 tonne of aluminarequires 2 to 3 tonnes of bauxite.

The aluminium production process can be categorised into upstream anddownstream activities. The upstream process involves mining and refining whilethe downstream process involves smelting and casting & fabricating.Downstream-fabricated products consist of rods, sheets, extrusions and foils.

Power is amongst the largest cost component in manufacturing of aluminium, asthe production involves electrolysis. Consequently, manufacturers are located

near cheap and abundant sources of electricity such as hydroelectric powerplants. Alternatively, they could set up captive power plants, which is the patternin India. Indian manufacturers are the lowest cost producers of the base metaldue to access to captive power, cheap labour and proximity to abundant supplyof raw material, i.e., bauxite.

The Indian aluminium sector is characterised by large integrated players likeHindalco and National Aluminium Company (Nalco). The other producers ofprimary aluminium include Indian Aluminium (Indal), now merged withHindalco, and Sterlite Industries.

The per capita consumption of aluminium in India continues to remain

abysmally low at1.2 kg as against nearly 15 to 18 kgs in the western world and10 kgs in China. This offers significant upside potential. The key consumerindustries in India are power, transportation, consumer durables, packaging andconstruction. Of this, power is the biggest consumer (about 48% of total)followed by infrastructure (20%) and transportation (about 10% to 15%).However, internationally, the pattern of consumption is in favour oftransportation, primarily due to large-scale aluminium consumption by theaviation space.

The metal has a long working life due to its propensity for recycling. Recycledmetal requires significantly less amounts of energy for manufacturing of primaryaluminium. Just to put things in perspective, the recycling of aluminium scrap

requires 5% of the energy required for primary smelting, which is astoundinglylower, considering that power is such a high cost component.

Key Points

Supply Supply of aluminum is in excess and any deficit can be imported at lowrates of duty. Currently, domestic production comfortably meets domesticrequirements.


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Demand

Demand for aluminium is estimated to grow at 6%-8% per annum in view of thelow per capita consumption in India. Also, demand for the metal is expected topick up as the scenario improves for user industries, like power, infrastructureand transportation.

Barriers to entry

Large economies of scale. Consequently, high capital costs.

Bargaining power of suppliers

Most domestic players operate integrated plants. Bargaining power is limited incase of power purchase, as Government is the only supplier. However, increasing

usage of captive power plants (CPP) will help to rationalise power costs to acertain extent in the long-term.

Bargaining power of customers

Being a commodity, customers enjoy relatively high bargaining power, as pricesare determined on demand and supply.

Competition

Competition is primarily on quality and price, as being a commodity,differentiation is difficult. However, the recent spate of consolidation hasreduced the competitive pressure in the industry. Further, increasing valueaddition to aluminium products has helped some companies protect themselvesfrom the high volatilities witnessed in this industry.

Financial Year '11

In CY 2010, the world aluminium consumption stood at around 41 Million tonnes(MT), a sharp increase of over 20% over 34 m tonnes consumption in CY 2009.The CY10 production stood marginally higher at 42 m tonnes against productionof 38 m tonnes in CY 09. The sharp rise in demand was the result of strong

recovery in the emerging market demand and primarily restocking led growth indeveloped markets. A sharp turnaround in the end user segments such asautomobiles, industrial and infrastructure and thrust on power sector growthpropelled the aluminium industry growth.


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In FY11, LME average aluminium prices remained strong at around USD $2,250an increase of over 21% over previous year's average prices. The appreciatingrupee though negated some of the LME price gains for domestic aluminiumproducers as the prices are dollar denominated. The prices continued to riseeven as inventory levels remained at their historic highs. This was the result oftightness in the physical market, with most inventories tied up at various

warehouses under financing deals.

Across the globe, the cost of production of aluminium increased sharply as inputcosts such as alumina and power surged.

Prospects

In CY11, the global aluminium demand is expected to remain strong and isexpected to increase by around 9% reaching to almost 45 m tonnes. The Chinesedemand is expected to rise by a healthy 11%. In India, the demand is expected toincrease at almost 14% with an improvement in industrial activity andautomobile growth. Over the medium term, thrust on power sector spending will

spur the aluminium demand.

Aluminium production is expected to increase in line with the demand. Themarket surplus is going to continue for a while. Strong prices have led manysmelters to restart their production in last one year.

The greatest challenge facing the industry is the continuous increase in rawmaterial prices which are showing no signs of going down. Most input costs suchas fuel oil, coal tar pitch, and caustic soda have increased along with the freightcosts. Alumina costs for non integrated smelters have gone up and may increasefurther.

Aluminium inventories across the globe are near all time high. But most of theseinventories are reportedly bound in financing deals and are not expected to floodthe market. The long term fundamentals are strong and the surplus is expectedto reduce significantly in the near future.

Aluminium - Structure

The aluminium industry in India can be classified as:

(a) The primary producers who produce ingots and billets (primary form ofaluminium) using bauxite.

(b) The secondary producers who add value to the ingots and billets to produce

semi-fabricated products

At present there are only five companies in the primary aluminium market viz.Hindalco, Indian Aluminum (Indal), Madras Aluminum (Malco), NationalAluminum (Nalco) and Bharat Aluminum (Balco). The former three are privatesector companies while the latter two are government owned.


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All the primary producers have integrated forward into the manufacture of highvalue semi-fabricated products like rods, rolled products, extrusions and foils.

Regulated till 1989

Until 1989, the Aluminum Control Order (ACO) required all domesticmanufacturers to ensure that atleast 50% of their ingot production was electricalgrade, for use by the transmission power industry. The government fixed ingotprices on the basis of a Retention Pricing Mechanism, taking into considerationthe average retention prices of all producers and a minimum return on equity.

The above control resulted in a skewed product mix and shortages of aluminumfor other sectors. The problem was further compounded by the vulnerablefinancial position of State Electricity Boards (the main users of electrical gradealuminum) and high import and excise duties. The producers resorted to inflatedprices for other types of aluminium to compensate for the disadvantages theysuffered because of this regulation.

The ACO was scrapped in 1989 and in 1991 the government lifted restrictions oncapacity additions resulting in a free market environment.

Aluminium - Inputs

The aluminium industry in India can be classified as: Captive power, amplebauxite reserves, coupled with cheap labour costs make Indian companiesamongst the most competitive aluminium producers globally.

The main raw material for the manufacture of aluminium include bauxite, causticsoda, calcined petroleum coke, coal tar pitch, and LS/FS furnace oil. The

production process for manufacture of aluminium is briefly outlined below.

The mined bauxite ore is mixed with caustic liquor and is refined to producealumina. This is then smelted (through electrolysis in a smelter) to obtainaluminium. Depending on the quality of bauxite, 2.5 3 tonnes are required formanufacture of 1 tonne of alumina. In turn, 2 tonnes of alumina are required formanufacture of 1 tonne of aluminium.


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Bauxite

Indian bauxite reserves at 3 bn tonnes, are the 5th largest in the world, andaccount for 6% of total world reserves. Most alumina refineries are designedaround the bauxite reserves to reduce transportation costs. Cost per tonne ofbauxite varies for players depending on the location of the refinery and bauxitemines.

For example, Nalco has an estimated 1,600 m tonnes of bauxite reserves only 20kms from its alumina refinery, enabling it to become one of the most economicalbauxite producers in the world.

Although domestic producers are self sufficient in alumina, the setting up ofindependent aluminium smelters all over the world and cut backs in Europeanand American alumina production have resulted in alumina gaining importanceas an internationally traded commodity. This has also been helped by therelocation of smelters based on the availability of cheap power. About 40% ofalumina production is traded between unrelated parties. Alumina prices

generally depend on the demand/supply and on the prices of aluminium. Bauxiteis the single largest cost item for the manufacture of alumina giving India acompetitive advantage. With this in mind, MoUs are being signed by companiesto set up alumina plants in bauxite-rich states like Orissa.

Power

Power constitutes the single largest cost component for aluminiummanufacturers (3540% of operating costs). Almost all the major Indiancompanies have captive power plants thus giving them access to cheap power.This makes India one of the most competitive low cost aluminium producers inthe world.

Hindalco and Nalcos production costs are amongst the lowest in the world. Bothcompanies have the advantage of 100% captive power, vital in a power intensiveindustry and in a power deficit country like India.

Aluminium - Products

Aluminium products can be segregated into rolled products, extrusions, and foils.


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Rolled products find applications in automobiles (paneling, floors and windows,but are yet to find use in structural parts and bodies), construction (roofing andwalls), consumer durables, engineering applications, web stock for laminatedpackaging (for toothpastes). A major portion of rolled products capacity is

accounted for by the five integrated producers (around 82%).

Extrusions include products as bars, pipes and tubes. Major users of extrudedaluminium products are buildings, transportation and electrical sector.Production in this segment is widely spread and the top three players controlaround 31% of the market (the largest company - Hindalco commands around14% market share in this segment).

Foils are sheets having thickness of less than 0.2 mm up to 0.006 mm findingapplication mainly in the packaging sector. Major users of aluminium foilsinclude the pharmaceutical, consumer products, cigarette and cablemanufacturing industries.

Equity Master Sector Report Aluminium

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