Adding value: Hindalco - Buy

With uncertainties and the volatility in the aluminium market this year, the stock of aluminium and copper manufacturing company, Hindalco Industries, has corrected by nearly 20 per cent year-to-date.

Lower-than-anticipated capacity cuts in China, tariff imposition on imports by the US and sanctions on Russian aluminium giant Rusal were hanging over metal companies.

However, the performance of Hindalco was robust in FY 2018, driven by a favourable product mix, better realisations and supportive macros.

Improving operational performance from Novelis, the US-based downstream arm of Hindalco, shift in focus from upstream to downstream facilities domestically will insulate the company from the industry’s cyclicality and the volatilities in the LME (London Metal Exchange) market to a certain extent. Maintaining debt at low levels is also a positive for the company.

The acquisition of Aleris, one of the largest manufacturers of aluminium products in the US, will help Novelis consolidate its position in the auto segment in the US and Europe.

At the current market price of ₹214, the stock is attractively valued at about eight times its trailing 12-month earnings, which is way lower than the average of 20 times that it traded over the past three years. Long-term investors with a moderate risk appetite can consider buying this stock.

Novelis lends strength

Novelis contributed nearly 62 and 53 per cent to the consolidated revenue and operating profits respectively, of the Hindalco group in FY 2018. It has also reported strong free cash flows of $406 million in the same period, a rise of 12 per cent y-o-y, led by robust operating profits and lower interest costs.

It derives its revenue from aluminium flat rolled products, mainly beverage cans (34 per cent market share), automotive sheets (45 per cent market share) and speciality products (5 per cent market share). These markets grew at compounded annual growth rates of 4, 76 and 5 per cent respectively, between 2010 and 2017, as per investor presentation of the company.

Novelis’ management is focused on the fast-growing auto segment that generates better margins and free cash flows. This thrust has been reinforced by the proposed investment of around $300 million in an automotive aluminium sheet manufacturing facility in Guthrie, Kentucky, which will add approximately 200 kilo tonnes (kt) of capacity.

Also, Aleris is a strong player in this segment and will help Novelis consolidate its presence, and is expected to increase the share of automotive sales to 22 per cent from the current 20 per cent.

Like Novelis, Aleris too is primarily in the downstream aluminium products business and gives the former, a presence in the construction and aerospace segments. It will add about one million tonne to Novelis, taking the group’s total capacity to around 4.7 million tonnes of downstream facilities.

Robust product mix

The domestic aluminium and copper businesses have contributed about 30 and 10 per cent respectively to the consolidated operating profits of the company in FY 2018.

The aluminium industry is expected witness demand pick-up over the next couple of years in the US, Europe and China. However, with the imposition of tariffs by the US and protectionist measures taken by other major consumers, there may be an increase in Indian imports, which are diverted from China and West Asia. Owing to oversupply in the country, the international premium (that is added to the LME prices) wouldn’t be realisable for the domestic players. There is already a discount to the MJP (main Japanese Port) aluminium premium in India currently.

This prompted the company to focus on value-added products that would be independent of LME prices. Hindalco plans to increase the downstream products by 12 per cent in the current year. It has also planned a capex of about ₹5,000 crore on downstream projects over the next five years.

The company does not have plans to expand the upstream aluminium business in India. Instead, its focus is on the alumina (raw material for aluminium) market to gain from the rising prices. The company is now expanding the existing alumina production capacity by 500 kt, which it expects to be a tough market in the future.

In the copper business too, the company has been shifting its focus to value-added products. For instance, it recently commissioned CCR-3 that converts produced cathodes to copper rods, that would generate additional revenue of $200 per tonne.

Healthy financials

In FY 2018, revenues increased by 13 per cent y-o-y to ₹115,808 crore. Novelis continued to grow at 15 per cent y-o-y in the same period.

The group’s profit after tax (PAT) has almost tripled to ₹6,083 crore in FY 2018 compared to the previous year.

The management has also strengthened the balance sheet by pre-paying debts of nearly ₹8,000 crore. As a result, the consolidated net debt-to-EBITDA stood at 2.82 times at the end of FY 2018 versus 3.74 times at the end of FY 2017.

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