Hindalco -Cautious on aluminium-Macquarie

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Hindalco Industries
Cautious on aluminium
Event
 2Q FY11 results below expectations: Hindalco reported standalone results
7% below estimates, impacted by higher costs in the aluminium division.
 Downgrading Hindalco to Neutral from Outperform, while maintaining
earnings and TP of Rs240. We believe the strong turnaround in Novelis drove
the strong stock performance and is factored in. The next catalyst, in our view,
is a three-fold increase in aluminium capacity in India at a very substantial
capex of US$8bn. This makes Hindalco highly leveraged and levered to the
aluminium price, which we believe has downside risks. We recommend a
switch to Sterlite Industries (STLT IN, Rs189.95 ,OP, TP: Rs218.00), for
which earnings are expected to double in next 2.5 years and is available at
the same valuations.


Impact
 Results – strength in aluminium prices helped: Net sales of Rs58.0bn for
2Q FY11 were up 18% YoY, driven by strong aluminium prices. EBITDA of
Rs6.4bn was up 5.3% YoY. PAT of Rs4.3bn was up 26% YoY, helped by
higher other income and lower interest.
 Increased reliance on aluminium prices makes us cautious: For FY11, we
estimate a 10% change in the aluminium price changes earnings by 14%.
However, as Indian operations increase capacity and earnings contribution,
we estimate sensitivity will rise to 18% and 28% for FY12 and FY13,
respectively. This makes Hindalco very vulnerable, given our negative view on
aluminium. We estimate the breakeven aluminium price required for
increasing earnings is US$2,145/t.
 Leveraging once again: We expect Hindalco’s ongoing expansion plan will
result in increased leverage once again, as the company will take close to
Rs238.5bn of debt to finance its capex of US$8bn. This would increase the
debt equity from the current 0.8x to 1.32x in FY12.
 Consensus estimates for FY12 look very aggressive: For FY12, the
consensus estimate is 10% above our estimate and we believe has downside
risks.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs240.00 based on a PER methodology.
 Catalyst: Novelis results for 2Q FY11.
Action and recommendation
 Switch to Sterlite Industries: We believe that Hindalco has turned around
very well and that its expansion plans are also on track. Unfortunately, the
aluminium market remains highly oversupplied and, hence, returns should be
low, making the current valuations look high. We shall look for a better entry
point and recommend a switch to Sterlite, which is available at 9.3x FY12E
and 7.6x FY13E, which is a sharp discount to Hindalco.