Operating margin¹ of Indian primary aluminium producers is expected to decline more than 1,200 basis points (bps) this fiscal to 22-24% — from a decadal high of 36% seen last fiscal — owing to lower realisations and higher cost of production, mainly power.

Domestic primary aluminium producers saw record earnings last fiscal on the back of strong realisations — prices reached a historical high amid post-Covid economic recovery, with the global aluminium market turning supply-deficit.

In the current fiscal, however, operating margin is seen retreating closer to past levels, but would still remain higher than the average of ~17% over fiscals 2017-21.

Despite the moderation in margin, operating profits may remain better than the past 5-year average, partly owing to strong domestic demand growth of 6-7% on-year for aluminium products, mainly from the power and construction sectors. The two comprise ~70% of total sales volume for these manufacturers.

A Crisil Ratings study of three domestic primary aluminium producers², which account for the entire domestic capacity of 4.1 million tonne (MT), shows as much.

For primary aluminium makers, profitability is a function of global and domestic factors that affect prices and costs.

London Metal Exchange (LME) prices for aluminium have fallen ~40% from its March 2022 peak to ~$2,300 per tonne currently. This is because of extended lockdown restrictions in China and growing recessionary pressures impacting global demand in the first half of calendar 2022. On the other hand, global supply remained robust driven by production increases in China amid relaxation of power restrictions. China has around 55% capacity share in the global market.

Says Ankit Hakhu, Director, Crisil Ratings, “Prices in the second half of the fiscal are expected to remain range-bound around current levels, supported by low inventory levels at LME and recent production cuts in Europe which may partly offset the impact of higher Chinese production. Overall, global demand is expected to contract 1-2% in calendar 2022 after growing over 5% in 2021, against an expectation of a moderate growth in global supply in the current year. Consequently, average LME price for the metal will range between $2,300-2,500 per tonne through fiscal 2023 (against $2,774 per tonne in fiscal 2022). Domestic realisations are also expected to dip in sync, as they are driven by the landed cost of imports.”

Alongside this, cost of production for domestic producers may rise 10% on-year, driven by rising coal prices. Power cost — constituting 30-35% of production costs — is projected to increase the most among all costs (by 40-50% on-year), fuelled by an increase in energy demand and disruption in global supply chains brought on by the Russia-Ukraine conflict.

Domestic producers rely on market purchases for ~30% of their coal requirements. Further, for linkage coal, materialisation will be lower this fiscal as priority is being accorded to the power sector.

Despite the increased cost of production, Indian producers are still among the lowest cost in the world — driven by highly integrated operations with 70-75% backward integration, on average. As a result, Indian producers currently export over 60% of their annual production (average of ~50% over the past five fiscals).

Says Ankush Tyagi, Associate Director, Crisil Ratings, “Domestic producers are undertaking capital expenditure (capex) to increase smelter capacity by ~ 30% and alumina refinery capacity by more than 100%³, along with increase in value-added capacities over the next five fiscals, at a total capital outlay of ~Rs 70,000 crore. This is on the back of healthy global and domestic demand outlook over the medium term, especially from sectors such as auto and renewables, along with limited capacity addition globally due to emission concerns.”

While capex intensity for domestic producers will increase, planned capex over the next five fiscals is likely to be around thrice that spent over the past five fiscals, annual operating profit for this fiscal, despite moderation, is expected to be sufficient to cover ongoing capex. This will support credit profiles.

Interest coverage ratio is projected to remain healthy at ~8x this fiscal compared with ~10x last fiscal, along with healthy cash buffers of more than 1x of debt obligations.

Going forward, a sharper-than-expected correction in global aluminium prices, weaker global and domestic demand, or significantly higher-than-expected input costs would bear watching.

¹ Operating margin is defined as earnings before interest, tax, depreciation and amortisation (Ebitda) margin
² Vedanta Ltd (including Bharat Aluminium Company Ltd), Hindalco Industries Ltd, and National Aluminium Company Ltd
³ Planned addition of smelter capacity of ~ 1.4 MT and alumina refinery capacity of ~ 10.4 MT by fiscal 2027