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We upgrade Hindalco to Outperform from In-Line.
Though we expect aluminium prices to have strong
downside support in the next few quarters, its impact
could be diluted by rising costs.
Near-term stock catalysts: Timely commissioning of its
Mahan smelter and clarity about Utkal Alumina’s capital
costs and commissioning schedule.
We expect Novelis to report strong earnings over the
next few quarters supported by non-cyclical products
(80-85% of production) and improving efficiency.
We raise FY12/13E EPS by 7.1%/5.3%, respectively.
We lower price target to Rs174 from Rs199
Expansion to drive volume – We expect Hindalco’s huge
Rs400bn expansion – in greenfield projects coming on
stream over FY12-14E – to lead to volume CAGR of 23.6%
and revenue CAGR of 26.8% over FY12-14E at its India
operations.
Production costs likely to increase – Non-availability of
linkage coal/delay in coal block development and rising
carbon/caustic soda prices could trim Hindalco’s profitability,
in our view.
Price of aluminium has strong cost-push support – We
expect rising energy costs and alumina prices to support
aluminium prices. Our global resources team is bullish on
coal – we estimate thermal coal could rise to US$150/tonne
going forward. In a scenario of rising coal and oil prices,
there will be cost-push support for aluminium. We assume a
spot price of US$2,500/ tonne in our forecasts.
Novelis to remain strong – We expect Novelis to generate
EBITDA of around US$330/tonne going forward. Earnings
volatility is likely to decline, in our view, given better risk
management practises. Only 15-20% of the Novelis’ product
is in the commodity category and hence the impact of a
slowdown in the west (if it happens) will be minimal.
Valuation: Price target of Rs174 – We rate the stock
Outperform with a price target of Rs174. We have valued it
at 7.0x FY13E EV/EBITDA. At our price target, Hindalco
would trade at 8.5x FY13E earnings.
Risks – The main risk is commodity prices. We have built in
aluminium price of US$2,500/tonne in FY12. If the price
fluctuates wildly, there is significant risk to our earnings
estimates.
Investment argument and valuation
Hindalco is undertaking the most aggressive expansion plan in its history – likely to result in
significant capacity addition from end FY12 onwards.
Backward integration (bauxite and coal) is likely to keep costs low for its India aluminium
division.
Non-cyclical product mix and improving operational performance are likely to maintain Novelis’
profitability.
Volume expansion key to future profitability
Hindalco’s aluminium division in India is highly profitable, given backward integration of bauxite
and coal. To leverage this advantage, it has undertaken a Rs400bn green field capacity
expansion plan – it is building three new smelters with capacity of 359,000 tpa along with three
900MW captive power plants. Of the three smelters, two (Mahan and Aditya Aluminium) are likely
to be commissioned in 2H FY12 and FY14, respectively. We expect cost effectiveness and
backward integration to help Hindalco improve profitability.
There is a small catch though. The coal block allotted to the Mahan smelter has been held up,
and we believe the issue will not be resolved prior to the smelter being commissioned. This would
raise Mahan’s power costs, impacting profitability in the short term. Until Hindalco resolves the
issue, the full potential of the expansion will not be realised.
Novelis to remain strong
Driven by a pickup in aluminium demand and cost cutting initiatives, Novelis has been able to
consistently report EBITDA/tonne of more than US$350. Given this, we expect Novelis to achieve
its target of adjusted EBITDA of above US$1bn.
Novelis has also improved its risk management practices, mainly to avoid volatility in earnings
arising from its large derivatives positions. This is reflected in the narrowing gap between EBITDA
and adjusted EBITDA in the past few quarters.
Cost pressures significant going forward
Although Hindalco is trying to get ‘tapering linkage’ to compensate for the delay in mine
development, we believe it is highly unlikely given that India faces significant coal shortages. For
example, while FY12 coal demand is likely to be 700m tonnes, domestic production might be only
550m tonnes. With linkage coal unlikely, the Mahan smelter will need to import coal or buy coal at
e-auctions, driving up the minimum cost per unit to Rs2.40, almost double current power costs.
We estimate Hindalco’s power costs could increase from the current Rs1.3/unit to around
Rs1.45/unit in FY13. Apart from power, prices of other key cost items such as caustic soda and
carbon, too, are rising.
Valuation framework
Hindalco India business valuation
We value the consolidated business at 7.0x FY13E EV/EBITDA to arrive at our price target of
Rs174/sh. We value Hindalco at a 16% premium to Nalco for the following reasons:
1. Massive earnings accretive expansion of Utkal Alumina will be functional in FY14 only.
2. Aditya Aluminium will be be commissioned in FY14 and its full impact will be felt in FY15.
This is a totally integrated capacity and hence its profitability will be much better than
Mahan’s. Our numbers show that standalone EPS will grow by 60% in FY15 over FY13
Risks
The main risk is commodity prices – we have built in aluminium price of US$2,500/tonne in FY13.
If the price fluctuates wildly, there is significant risk to our earnings estimates.
If the company receives linkage coal from Coal India, its power cost will be lower than estimated.
Considering that aluminium smelting is a power intensive business (15,000 kWh for one tonne),
lower power costs could provide significant upside to our earnings estimates
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
We upgrade Hindalco to Outperform from In-Line.
Though we expect aluminium prices to have strong
downside support in the next few quarters, its impact
could be diluted by rising costs.
Near-term stock catalysts: Timely commissioning of its
Mahan smelter and clarity about Utkal Alumina’s capital
costs and commissioning schedule.
We expect Novelis to report strong earnings over the
next few quarters supported by non-cyclical products
(80-85% of production) and improving efficiency.
We raise FY12/13E EPS by 7.1%/5.3%, respectively.
We lower price target to Rs174 from Rs199
Expansion to drive volume – We expect Hindalco’s huge
Rs400bn expansion – in greenfield projects coming on
stream over FY12-14E – to lead to volume CAGR of 23.6%
and revenue CAGR of 26.8% over FY12-14E at its India
operations.
Production costs likely to increase – Non-availability of
linkage coal/delay in coal block development and rising
carbon/caustic soda prices could trim Hindalco’s profitability,
in our view.
Price of aluminium has strong cost-push support – We
expect rising energy costs and alumina prices to support
aluminium prices. Our global resources team is bullish on
coal – we estimate thermal coal could rise to US$150/tonne
going forward. In a scenario of rising coal and oil prices,
there will be cost-push support for aluminium. We assume a
spot price of US$2,500/ tonne in our forecasts.
Novelis to remain strong – We expect Novelis to generate
EBITDA of around US$330/tonne going forward. Earnings
volatility is likely to decline, in our view, given better risk
management practises. Only 15-20% of the Novelis’ product
is in the commodity category and hence the impact of a
slowdown in the west (if it happens) will be minimal.
Valuation: Price target of Rs174 – We rate the stock
Outperform with a price target of Rs174. We have valued it
at 7.0x FY13E EV/EBITDA. At our price target, Hindalco
would trade at 8.5x FY13E earnings.
Risks – The main risk is commodity prices. We have built in
aluminium price of US$2,500/tonne in FY12. If the price
fluctuates wildly, there is significant risk to our earnings
estimates.
Investment argument and valuation
Hindalco is undertaking the most aggressive expansion plan in its history – likely to result in
significant capacity addition from end FY12 onwards.
Backward integration (bauxite and coal) is likely to keep costs low for its India aluminium
division.
Non-cyclical product mix and improving operational performance are likely to maintain Novelis’
profitability.
Volume expansion key to future profitability
Hindalco’s aluminium division in India is highly profitable, given backward integration of bauxite
and coal. To leverage this advantage, it has undertaken a Rs400bn green field capacity
expansion plan – it is building three new smelters with capacity of 359,000 tpa along with three
900MW captive power plants. Of the three smelters, two (Mahan and Aditya Aluminium) are likely
to be commissioned in 2H FY12 and FY14, respectively. We expect cost effectiveness and
backward integration to help Hindalco improve profitability.
There is a small catch though. The coal block allotted to the Mahan smelter has been held up,
and we believe the issue will not be resolved prior to the smelter being commissioned. This would
raise Mahan’s power costs, impacting profitability in the short term. Until Hindalco resolves the
issue, the full potential of the expansion will not be realised.
Novelis to remain strong
Driven by a pickup in aluminium demand and cost cutting initiatives, Novelis has been able to
consistently report EBITDA/tonne of more than US$350. Given this, we expect Novelis to achieve
its target of adjusted EBITDA of above US$1bn.
Novelis has also improved its risk management practices, mainly to avoid volatility in earnings
arising from its large derivatives positions. This is reflected in the narrowing gap between EBITDA
and adjusted EBITDA in the past few quarters.
Cost pressures significant going forward
Although Hindalco is trying to get ‘tapering linkage’ to compensate for the delay in mine
development, we believe it is highly unlikely given that India faces significant coal shortages. For
example, while FY12 coal demand is likely to be 700m tonnes, domestic production might be only
550m tonnes. With linkage coal unlikely, the Mahan smelter will need to import coal or buy coal at
e-auctions, driving up the minimum cost per unit to Rs2.40, almost double current power costs.
We estimate Hindalco’s power costs could increase from the current Rs1.3/unit to around
Rs1.45/unit in FY13. Apart from power, prices of other key cost items such as caustic soda and
carbon, too, are rising.
Valuation framework
Hindalco India business valuation
We value the consolidated business at 7.0x FY13E EV/EBITDA to arrive at our price target of
Rs174/sh. We value Hindalco at a 16% premium to Nalco for the following reasons:
1. Massive earnings accretive expansion of Utkal Alumina will be functional in FY14 only.
2. Aditya Aluminium will be be commissioned in FY14 and its full impact will be felt in FY15.
This is a totally integrated capacity and hence its profitability will be much better than
Mahan’s. Our numbers show that standalone EPS will grow by 60% in FY15 over FY13
Risks
The main risk is commodity prices – we have built in aluminium price of US$2,500/tonne in FY13.
If the price fluctuates wildly, there is significant risk to our earnings estimates.
If the company receives linkage coal from Coal India, its power cost will be lower than estimated.
Considering that aluminium smelting is a power intensive business (15,000 kWh for one tonne),
lower power costs could provide significant upside to our earnings estimates
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