Credit Suisse: Hindalco- Novelis: liberties and restrictions under the new covenants

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Hindalco------------------------------------------------------------------------- Maintain OUTPERFORM
Novelis: liberties and restrictions under the new covenants


● We analyse covenants for new debt at Novelis. These would be
suspended if Novelis gets investment grade by S&P or Moody’s.
Room for further leverage at Novelis: New covenants allow Novelis
to further increase its debt by about US$1.4 bn by FY12 and by
about US$2 bn by FY14 (Fig 1). Out of the two covenants here, net
debt/adjusted EBITDA is more constraining than the interest
coverage covenant.

● Acquisition related debt increase is limited to US$400 mn. This
limits acquisition size to US$800 mn if D/E is 1:1. However, Novelis
has liberty to raise non-recourse debt at the target.
● Dividends can be paid now. Earlier, the dividends were restricted as
cumulative net income since September 2005 was negative. The new
covenants have reset the date to October 2010 =>dividends can be
paid. An additional US$150 mn distribution allowed per year if net
debt/adjusted EBITDA is ≤ 3.5x (current 3.9x).
● High interest cost at Novelis should sustain. Average interest cost
for the new bonds is higher by 73 bp but the high redemption
premium (Fig 3) implies that unless Novelis can refinance its debt
170 bp lower till CY15, high interest cost should sustain.
New covenants at Novelis allow it to take more debt
New US$4 bn debt at Novelis comprise 1) US$1.5 bn senior secured
facility 2) US$1.1 bn unsecured bonds due 2017 (8.375%) and
3) US$1.4 bn unsecured bonds due 2020 (8.75%). Two main
covenants for the US$1.5 bn senior secured facility are 1) Net leverage
ratio (net debt/adjusted EBITDA) which needs to comply with the
covenants as per Fig 1, and 2) Interest coverage ratio which should be
≥ 2x (currently 3.1x on the expanded debt so Novelis is comfortably
placed). We also scanned the covenants of Crown Holdings in Fig 2 (a
customer of Novelis) and the covenants are not too different.

These covenants have an important implication on how much further
debt can be raised at Novelis. Total net debt at Novelis is US$3.8 bn
currently and if Novelis achieves EBITDA of US$1.3 bn-plus in FY14
then the leverage covenant allows it to further increase debt by about
US$2 bn.
Acquisition related debt increase limited to max of US$400
mn
The total debt that Novelis could use to finance an acquisition is
limited to maximum of US$400 mn and 7.5% of net tangible assets.
Assuming D/E of 1:1, the transaction size is limited to US$800 mn.

However, Novelis can raise non-recourse debt at the target.
Restricted payment basket clause now reset to 1 Oct 2010
Novelis was not able to pay dividend to Hindalco till now, as the earlier
covenant required that cumulative dividend should be less than 50% of
cumulative net income starting from September 2005 quarter till the
last quarter of the reported financials. As the cumulative net income
since September 2005 was in deficit, no dividends could be paid out.
Now the starting date for aggregation of net income has been changed
to 1-October 2010 and therefore, dividend could be paid to Hindalco.
Additionally, Novelis can also make a distribution of US$150 mn per
year starting 1 April 2011 if net debt/adjusted EBITDA ratio after the
payout is ≤ 3.5x. Both the covenants above would be suspended during
periods when net debt/adjusted EBITDA is ≤ 3.0x (currently 3.9x).

High redemption cost => Interest cost should remain high
Average interest cost for Novelis for the new bonds is higher by 73 bp.
Novelis has an option to redeem both 2017 and 2020 bonds (Fig 3),
but our analysis suggests that unless Novelis can refinance its debt
170 bp lower till CY15, the redemption should not be profitable.
Therefore, high interest cost at Novelis should sustain at least till CY15.