RBS: buy Hindalco- target price up at 229

Hindalco Industries
Taking a fresh look at valuations
With Novelis returning to stable earnings, we switch to valuing it on a DCF basis.
In addition, given Hindalco’s robust expansion pipeline, which will not deliver
earnings until after FY12, we now value CWIP at 0.5x P/B. Based on these
revisions, we arrive at a target price of Rs229 (from Rs183). Maintain Buy.


Novelis: Switch to DCF-based valuation – Rs127/share
Novelis – acquired in 2007 – has been a notable turnaround story and has emerged out of
the shadow of fixed price contracts, which has enabled its EBITDA to grow from US$450m in
FY09 to US$750m in FY10. Going forward, we expect Novelis’s EBITDA to stabilise at
US$1bn in FY11F and beyond, and we therefore move to a DCF-based valuation
methodology vs our earlier approach of an EV/EBIDTA multiple based on comparable peers.
Following the change, we arrive at a value for Novelis of Rs127 per share of Hindalco.
Correlation with aluminium price weakens
The correlation of Hindalco’s stock price with the LME aluminium price has weakened to 0.67
since the acquisition of Novelis was announced in February 2007. The correlation had
averaged 0.94 from 2000 to 2007. With new contracts renewed on a per-tonnage basis,
Novelis’s pass-through business model should act as a natural hedge against volatile
aluminium prices. We believe Hindalco’s strategy to enter downstream value-addition
business through the acquisition is proving successful.
Planned CWIP pipeline becoming robust
The brownfield expansion of the Hirakud smelter to 213kt is scheduled to be completed by
4QFY12. The greenfield projects of 1.5mt Utkal Alumina – 359kt each of Mahan Aluminium
and Aditya Aluminium – are also on track to be commissioned by 2Q-3QFY12, although we
are more sceptical about the chances of the greenfield projects being commissioned on time
given the risks involved. However, as capex is due to pick up substantially in the coming
quarters, we now value the capital work in progress (CWIP) at 0.5x P/B (rather than 1x, as
these are new greenfield projects at new locations and therefore have higher risk of timely
execution, and also to factor in time value) and derive a value of Rs23/share. We continue to
value the domestic operations at 6x FY12F EBITDA and, as explained above, shift to a DCF
approach for Novelis. Based on these revisions, we raise our target price for Hindalco to
Rs229 (from Rs183) and maintain our Buy rating.