Company update: Hindalco Industries (Outperformer) - Price fall- a buying opportunity
Hindalco (HNDL)’s share price has corrected by ~16% last month owing to general weakness in the commodity market, fear of fall in aluminum prices on lower-than-expected winter production cuts in China and rumour that HNDL would buy US-based aluminum maker, Aleris. We believe the stock price fall provides a buying opportunity as ~65% of HNDL’s FY19E EBITDA is insulated from aluminum price fluctuations. Even if HNDL buys Aleris, we expect it to be value accretive for HNDL at or below US$3bn. We reiterate our Outperformer rating with a target price of Rs322, valuing India business at 6.5x FY19E EV/EBITDA and Novelis at 7.0x FY19E EV/EBITDA.
China supply reforms intact; cost support to keep aluminum prices firm: London Metal exchange (LME) aluminum price has corrected by ~7% to US$2,052/t (1% higher than August 2017 average) from its recent high of ~US$2,200/ton lower-than-expected winter production cuts in China. However, we believe the market is ignoring a few things: (1) supply reforms taken by China by closing down illegal smelters (~3.5mtpa) which are unlikely to be restored in a hurry (2) falling China exports (3) high raw material costs, which results in loss for non-integrated producers. As a result, we do not expect aluminum prices to fall significantly from the current level.
HNDL’s earnings less sensitive to aluminum prices: HNDL’s convertor businesses, Novelis (~55% of FY19E EBITDA) and copper (~10% of FY19E EBITDA) are expected to contribute ~65% to FY19E EBITDA. Moreover, ~23% of HNDL’s FY19E aluminium volume is hedged at ~US$2,000/t. As a result, even if LME aluminum price falls further by 5% to US$1,950/t, this would impact FY19E EBITDA by 6% and TP by 8% to Rs295.
Valuation: Our top pick with a target price of Rs322: In its Q2FY18 concall, Novelis mentioned that it would prefer to expand capacities organically. However, we believe even if HNDL acquires Aleris at ~US$3bn, it would be positive over the long term. HNDL’s earnings are less susceptible to fluctuation in aluminum prices and this bodes well for the company’s cash flows. We value the company’s India operations at 6.5x FY19E EV/EBITDA and Novelis at 7.0x FY19E EV/EBITDA to arrive at our target price of Rs322. We reiterate Outperformer on the stock.
Hindalco Industries is engaged in the production and sale of aluminum and copper in India and internationally. Co.'s aluminum products include rolled products, extrusions, foils, primary aluminum ingots, billets, wire rods, and aluminum slabs; and aluminum chemicals, such as standard alumina, standard hydrate and specialty aluminas and hydrates for use in refractories, ceramics, fire retardant plastics, alum, and zeolite applications. Co. also offers aluminum foil and packaging solutions to pharmaceuticals, healthcare, dairy, confectionery, processed foods, personal products, and tobacco industries, as well as to the heat, ventilation, and air conditioning industries.
IDFC Securities Ltd., a subsidiary of the Infrastructure Development Finance Company (IDFC) wherein the Government of India holds a 20% interest, is India's leading equities broker catering to most of the prominent financial institutions, both foreign and domestic investing in Indian equities. A research team of experienced and dedicated experts ensures the flow of critically investigated stock ideas and portfolio strategies for our clients. Our coverage spans across various growth sectors such as agriculture, automobiles, Consumer Goods, Technology, Healthcare, Infrastructure, Media, Power, Real Estate, Telecom, Capital Goods, Logistics, Cement amongst other sectors. Our clients value us for our strong research-led investment ideas, superior client servicing track record and exceptional execution skills.
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