Kotak Sec recommends: Hindalco: Raise Price Target to Rs 225

Outperformance likely to continue. We increase our target on Hindalco to Rs225
from Rs200 earlier on roll over to FY2012E financials. Our target price is based on a
conservative aluminium price assumption of US$2,050/ ton for FY2012E. We expect
aluminium prices to remain in a narrow band as positives of demand uptick and support
from high-cost structures are offset by high inventory and decreasing attractiveness of
financing deals. Our positive view is predicated on strong Novelis-led performance in
the near term and gains from capacity expansion in the medium term.




Raising target price to Rs225; still our preferred pick in the metal space
We raise our target price for Hindalco to Rs225 on (1) target price roll over to FY2012E financials
and (2) marginal revision in estimates after updation of the annual report. Our target price is based
on conservative per ton aluminium price assumption of US$1,950 and US$2,050 for FY2011E and
FY2012E. Our target price has 6.5% upside based on spot aluminium prices of US$2,203/ton.
Hindalco trades at 6.2X and 5.2X FY2011E and FY2012E EBITDA, adjusting for CWIP resulting
from greenfield expansion programs. Note that we do not ascribe any valuation, over the capital
invested, to greenfield expansion projects of Mahan and Aditya aluminium smelters.
Aluminium prices likely to move in US$2000-2200/ ton band
Aluminium cash to 3-month forward spread briefly slipped into backwardation before recovering.
We expect aluminium prices to move in a band of US$2,000-2,200/ ton. On the one hand, current
aluminium prices is lower than Chinese marginal cost of production of RmB15,000 -15,500/ ton
(US$2,196-2,270/ ton), as per CRU. On the other hand, an all-time high inventory (locked in
financing deals, which will eventually unwind) will keep the aluminium prices under check. LME
and total inventory stands at nine weeks and six weeks of total consumption. We expect strong
support to metal prices around US$1,900 / ton, the 75th percentile cash cost for smelter globally
(note that the current industry capacity utilization stands at 81%). We do not expect the prices to
increase beyond US$2,200, a level at which over 90% of the smelter will recover cash cost of
production.
Stock drivers: Novelis in the near term and capacity expansion in the long term
Capacity limitations and strong growth in flat rolled products (FRP) will continue to drive Novelis’
performance. Recently, Novelis increased the conversion premium for the specialty sheet products
it sells to European distribution and industrial customers by ~EUR100/ ton. In addition, potential is
high for renegotiation of beverage can contracts. Novelis is on track to generate US$1 bn+
EBITDA. We also expect significant value accretion from greenfield expansion plans. We expect the
cost of production of the new aluminium smelters to be US$1,100/ ton, which will place it
comfortably in the first quartile of the global cost curve.