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Action: Initiate with Buy for stable Novelis and Indian expansion
We believe Hindalco is in an exciting phase as its expansion plans near
completion and volume growth is expected by the end of FY13F with the
commissioning of the Mahan smelter. At the same time, Novelis, which
Hindalco acquired five years ago, has been a steady performer despite
global economic uncertainties and, in our view, should see continued
improvement with the focus on recycling and expansion in growth markets
of China, Korea and South America.
The stock has corrected by 30% over the past seven months (vs. a 2%
correction in SENSEX) on weak aluminium prices and uncertainty of coal
block development. However, we believe that even without captive coal,
the stock has attractive upside potential. At the same time, a weak INR
should mitigate the impact of lower aluminium prices.
Catalyst: Commissioning of the projects at Mahan and Utkal
Commissioning of the Mahan smelter and Utkal alumina over the next 6-
12 months would be a key trigger for the stock, in our view.
Valuation: Too much negativity built in
We value Hindalco at INR143/share at 6x FY14F EV/EBITDA with Indian
operations contributing INR72/share, Novelis INR54/share and other
stakes at INR17/share. HNDL is currently trading at 5.3x FY14F P/E and
0.6x FY13F P/B. We believe that the current share price is not valuing the
capex spend, despite the company expecting the expansion project to be
commissioned by the year-end.
Hindalco is the largest aluminium company in India with a capacity of 0.5mtpa and has a
worldwide presence through Novelis (which it acquired in May 2007). Hindalco is also
present in the copper smelting business with a capacity of 0.5mtpa.
Hindalco has large expansion plans to triple its capacity from the current level and is at
an exciting phase with its expansion plans nearing completion and volume growth
expected to start by the end of FY13 with the commissioning of the 0.36mtpa Mahan
smelter. At the same time, Novelis has been a steady performer despite global economic
uncertainties and should see continued improvement with focus on recycling and
expansion in growth markets of China, Korea and South America.
Initiate coverage with BUY rating and target price of INR143
We initiate coverage of Hindalco with a BUY rating and target price of INR143.
• We expect Novelis to continue to record robust performance driven by efficient
operations and judicious capex plans. The company is investing in growing markets of
Asia and South America and is focusing on expanding recycling capacity across the
regions. These two factors should lead to another inflection in Novelis EBITDA by
FY15, we believe.
• Its Indian expansion is nearing completion and even without captive coal blocks, the
projects would be profitable, in our view. With a captive bauxite mine, Hindalco will
have an advantage of USD200/tonne in cost of production which should keep it in a
much better shape than peers such as Vedanta Aluminium (not listed), which is a lossmaking
entity.
Recent stock price correction provides attractive opportunity
Hindalco’s stock price has corrected by 30% over the last seven months (vs 2%
correction in SENSEX and 18% correction in the BSE metals index) primarily on account
of: 1) weak global macroeconomic conditions; 2) concerns about coal block development
– development of coal blocks had been stuck for various government approvals, and
now with the CAG report questioning the methodology of allocating coal blocks, there are
concerns that it might be delayed further; and 3) temporary power-related issues –the
power plant had to be shut down temporarily, which affected aluminium production in
Q1FY13.
We believe the recent correction provides an attractive entry point given our view that:
1) Novelis remains a pillar of strength and should see continued strong profitability with
higher recycling and strategic investment; and 2) Indian operations should see strong
EBITDA growth despite a delay in coal block development as we expect Hindalco’s cost
of production to remain less than USD1,700/tonne despite external coal usage.
Aluminium prices bottoming, weak INR a tailwind
Aluminium prices on the London Metal Exchange are down sharply to USD1,900/tone,
(down 20% over last six months) primarily on weaker European outlook and fears of
slowdown in China. While we believe aluminium prices have bottomed out, we don’t
expect significant recovery in aluminium prices as 1) aluminium remains in surplus
despite production cuts in effect; and 2) global macro conditions remain sluggish.
At the same time, we believe close to 50% of global aluminium smelters have turned
unprofitable at current aluminium prices. This should provide a floor to aluminium prices.
However realizations in terms of rupees have been helped by weak currency (INR has
depreciated by 12% over last six months), and blended realizations for HNDL should
remain flat to marginally positive YoY. Since most of the costs are in INR, we expect
profitability to remain intact for Hindalco.
Novelis has been a successful acquisition…
Novelis has been a remarkable success for Hindalco as EBITDA has doubled to
USD1bn in FY10 and has maintained an annual run rate of USD0.9-1bn consistently for
the past 2-3 years. At the same time, Novelis has paid back cash of USD1.7bn to
Hindalco in FY11. Novelis is largely a converter with very stable margins (as its margins
are not impacted by the volatility of aluminium prices). The company has also been able
to operate at full capacity despite the weak economic environment as 60% of its
deliveries are in beverage cans for which there is very stable demand.
Focus on recycling, growth projects: expect 2nd EBITDA
inflection in FY15-16F
Novelis experienced an inflection in its EBITDA in FY10, when EBITDA doubled to
around the USD1bn level. We expect another inflection in EBITDA from FY15F as the
company is investing heavily in: 1) expansion in Asian and South American markets; and
2) expanding its recycling capacity at most of its facilities which should improve the use
of recycled aluminium by Novelis to 50% in FY16F from the current rate of 37.5%.
The FY10 inflection in EBITDA was on account of: 1) an increased focus on profitable
business segments – ie, beverage cans; 2) higher conversion margin; and
3) restructuring of operations. We believe the inflection in FY15F will be more internally
driven by judicious and focused capex.
Indian operations: expansion nearing completion
Hindalco plans to increase aluminium smelting capacity to 1.64mn tonnes (from 0.5mn
tonnes currently) and alumina refining capacity to 4.5mn tonnes (from 1.5mn tonnes
currently) by FY15-16F. This would make Hindalco amongst the largest integrated
aluminium companies in the world. Hindalco is also expanding captive power capacity to
4000MW from close to 1100MW currently, which would be sufficient to meet its 100%
energy requirement.
While Indian companies in general have faced major hindrances in their expansion
plans, with Hindalco also having its shares of problems, we believe the projects now
have improved visibility of getting commissioned.
Hindalco’s projects are viable even without captive coal...
All of Hindalco’s expansion plans have been allocated bauxite mines as well as coal
blocks by the government. While development of coal blocks has been lagging due to
various approval issues, bauxite mine development is going on as per schedule.
While coal block would boost the profitability of the Mahan smelter, we believe that even
without it, the cost of aluminium production would be ~USD1,650/tonne. Balco (not
listed) and Vedanta Alumina (not listed) have aluminium cost of production of USD1,900-
1,950/tonne. Hindalco, owing to its captive bauxite mine, should have an advantage of
USD200-250/tonne. Therefore, we estimate the Mahan smelter can generate
EBITDA/tonne of USD600- USD650, which would be enough to meet the interest/debt
obligation.
Phase wise commissioning to keep leverage under control
Hindalco has a capex plan of USD3.5bn over the next 3 years in India and close to
USD1.5bn at Novelis. As a result, we expect standalone net debt to increase to USD3bn
in FY14F from USD1.7bn in FY12, and on a consolidated basis, net debt should be close
to USD7.5bn in FY14F from USD6bn in FY12.
However, we believe D/E should remain at around 1:1 on a consolidated basis and
interest coverage ratio should be at a healthy 4.5-5x. Novelis has debt of USD4bn (out of
total consolidated net debt of USD7bn), and it should have sufficient cash flows to meet
all its capex and interest servicing needs.
Action: Initiate with Buy for stable Novelis and Indian expansion
We believe Hindalco is in an exciting phase as its expansion plans near
completion and volume growth is expected by the end of FY13F with the
commissioning of the Mahan smelter. At the same time, Novelis, which
Hindalco acquired five years ago, has been a steady performer despite
global economic uncertainties and, in our view, should see continued
improvement with the focus on recycling and expansion in growth markets
of China, Korea and South America.
The stock has corrected by 30% over the past seven months (vs. a 2%
correction in SENSEX) on weak aluminium prices and uncertainty of coal
block development. However, we believe that even without captive coal,
the stock has attractive upside potential. At the same time, a weak INR
should mitigate the impact of lower aluminium prices.
Catalyst: Commissioning of the projects at Mahan and Utkal
Commissioning of the Mahan smelter and Utkal alumina over the next 6-
12 months would be a key trigger for the stock, in our view.
Valuation: Too much negativity built in
We value Hindalco at INR143/share at 6x FY14F EV/EBITDA with Indian
operations contributing INR72/share, Novelis INR54/share and other
stakes at INR17/share. HNDL is currently trading at 5.3x FY14F P/E and
0.6x FY13F P/B. We believe that the current share price is not valuing the
capex spend, despite the company expecting the expansion project to be
commissioned by the year-end.
Hindalco is the largest aluminium company in India with a capacity of 0.5mtpa and has a
worldwide presence through Novelis (which it acquired in May 2007). Hindalco is also
present in the copper smelting business with a capacity of 0.5mtpa.
Hindalco has large expansion plans to triple its capacity from the current level and is at
an exciting phase with its expansion plans nearing completion and volume growth
expected to start by the end of FY13 with the commissioning of the 0.36mtpa Mahan
smelter. At the same time, Novelis has been a steady performer despite global economic
uncertainties and should see continued improvement with focus on recycling and
expansion in growth markets of China, Korea and South America.
Initiate coverage with BUY rating and target price of INR143
We initiate coverage of Hindalco with a BUY rating and target price of INR143.
• We expect Novelis to continue to record robust performance driven by efficient
operations and judicious capex plans. The company is investing in growing markets of
Asia and South America and is focusing on expanding recycling capacity across the
regions. These two factors should lead to another inflection in Novelis EBITDA by
FY15, we believe.
• Its Indian expansion is nearing completion and even without captive coal blocks, the
projects would be profitable, in our view. With a captive bauxite mine, Hindalco will
have an advantage of USD200/tonne in cost of production which should keep it in a
much better shape than peers such as Vedanta Aluminium (not listed), which is a lossmaking
entity.
Recent stock price correction provides attractive opportunity
Hindalco’s stock price has corrected by 30% over the last seven months (vs 2%
correction in SENSEX and 18% correction in the BSE metals index) primarily on account
of: 1) weak global macroeconomic conditions; 2) concerns about coal block development
– development of coal blocks had been stuck for various government approvals, and
now with the CAG report questioning the methodology of allocating coal blocks, there are
concerns that it might be delayed further; and 3) temporary power-related issues –the
power plant had to be shut down temporarily, which affected aluminium production in
Q1FY13.
We believe the recent correction provides an attractive entry point given our view that:
1) Novelis remains a pillar of strength and should see continued strong profitability with
higher recycling and strategic investment; and 2) Indian operations should see strong
EBITDA growth despite a delay in coal block development as we expect Hindalco’s cost
of production to remain less than USD1,700/tonne despite external coal usage.
Aluminium prices bottoming, weak INR a tailwind
Aluminium prices on the London Metal Exchange are down sharply to USD1,900/tone,
(down 20% over last six months) primarily on weaker European outlook and fears of
slowdown in China. While we believe aluminium prices have bottomed out, we don’t
expect significant recovery in aluminium prices as 1) aluminium remains in surplus
despite production cuts in effect; and 2) global macro conditions remain sluggish.
At the same time, we believe close to 50% of global aluminium smelters have turned
unprofitable at current aluminium prices. This should provide a floor to aluminium prices.
However realizations in terms of rupees have been helped by weak currency (INR has
depreciated by 12% over last six months), and blended realizations for HNDL should
remain flat to marginally positive YoY. Since most of the costs are in INR, we expect
profitability to remain intact for Hindalco.
Novelis has been a successful acquisition…
Novelis has been a remarkable success for Hindalco as EBITDA has doubled to
USD1bn in FY10 and has maintained an annual run rate of USD0.9-1bn consistently for
the past 2-3 years. At the same time, Novelis has paid back cash of USD1.7bn to
Hindalco in FY11. Novelis is largely a converter with very stable margins (as its margins
are not impacted by the volatility of aluminium prices). The company has also been able
to operate at full capacity despite the weak economic environment as 60% of its
deliveries are in beverage cans for which there is very stable demand.
Focus on recycling, growth projects: expect 2nd EBITDA
inflection in FY15-16F
Novelis experienced an inflection in its EBITDA in FY10, when EBITDA doubled to
around the USD1bn level. We expect another inflection in EBITDA from FY15F as the
company is investing heavily in: 1) expansion in Asian and South American markets; and
2) expanding its recycling capacity at most of its facilities which should improve the use
of recycled aluminium by Novelis to 50% in FY16F from the current rate of 37.5%.
The FY10 inflection in EBITDA was on account of: 1) an increased focus on profitable
business segments – ie, beverage cans; 2) higher conversion margin; and
3) restructuring of operations. We believe the inflection in FY15F will be more internally
driven by judicious and focused capex.
Indian operations: expansion nearing completion
Hindalco plans to increase aluminium smelting capacity to 1.64mn tonnes (from 0.5mn
tonnes currently) and alumina refining capacity to 4.5mn tonnes (from 1.5mn tonnes
currently) by FY15-16F. This would make Hindalco amongst the largest integrated
aluminium companies in the world. Hindalco is also expanding captive power capacity to
4000MW from close to 1100MW currently, which would be sufficient to meet its 100%
energy requirement.
While Indian companies in general have faced major hindrances in their expansion
plans, with Hindalco also having its shares of problems, we believe the projects now
have improved visibility of getting commissioned.
Hindalco’s projects are viable even without captive coal...
All of Hindalco’s expansion plans have been allocated bauxite mines as well as coal
blocks by the government. While development of coal blocks has been lagging due to
various approval issues, bauxite mine development is going on as per schedule.
While coal block would boost the profitability of the Mahan smelter, we believe that even
without it, the cost of aluminium production would be ~USD1,650/tonne. Balco (not
listed) and Vedanta Alumina (not listed) have aluminium cost of production of USD1,900-
1,950/tonne. Hindalco, owing to its captive bauxite mine, should have an advantage of
USD200-250/tonne. Therefore, we estimate the Mahan smelter can generate
EBITDA/tonne of USD600- USD650, which would be enough to meet the interest/debt
obligation.
Phase wise commissioning to keep leverage under control
Hindalco has a capex plan of USD3.5bn over the next 3 years in India and close to
USD1.5bn at Novelis. As a result, we expect standalone net debt to increase to USD3bn
in FY14F from USD1.7bn in FY12, and on a consolidated basis, net debt should be close
to USD7.5bn in FY14F from USD6bn in FY12.
However, we believe D/E should remain at around 1:1 on a consolidated basis and
interest coverage ratio should be at a healthy 4.5-5x. Novelis has debt of USD4bn (out of
total consolidated net debt of USD7bn), and it should have sufficient cash flows to meet
all its capex and interest servicing needs.
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