Company update: Hindalco Industries (Outperformer) - Wish Novelis is listed

Hindalco’s (HNDL IN) share price has corrected 15% from its high in last six months, despite sound fundamentals and limited risk of earnings downgrade. While we expect no downside risk, we have upgraded our EBITDA estimates by ~1% for FY19E and by ~6% for FY20E, primarily due to rupee depreciation. However, we have reduced our valuation for India operation to 5.5x (earlier 6.5x) and for Novelis to 6.5x (earlier 7.0x) to factor in any slowdown in China, amid the ongoing trade war. As a result, we have cut our target price to Rs323 (earlier Rs346), which still presents 42% upside to the stock from the current level. Reiterate Outperformer.

Novelis’ peers trade at an average 7.2x 1-year forward EV/EBITDA: Firm demand and improved product mix, should enable Novelis (contributed ~55% to Hindalco’s consolidated EBITDA in FY18) to post 5% EBITDA CAGR over FY18-20E, in our view. We expect the company to command a premium over global peers. (global peers trade at an average 1-year forward EV/EBITDA of 7.2x), given Novelis’ superior return ratios (RoCE to improve from 9.2x in FY16 to 14.7x in FY19E) and sustainable earnings. Incidentally, the market has not ascribed similar multiples to Novelis, perhaps considering the risks from investing in emerging markets. We would hope for Novelis to be listed overseas.

FY20E earnings upgrade factors in rupee depreciation: We expect aluminium prices to inch up on (1) firm global demand for aluminium (2) supply discipline by China producers, enabling market equilibrium in China (3) continued high cost of production (COP), causing over 40% of global producers to sustain losses. Although we have not altered our average aluminium price of US$2,150/t for FY20E, we have reworked our exchange rate estimates (assumption revised from INR/USD of 67.5 to 70.0 in FY19E and 68.0 to 72.0 in FY20E), which would offset the high cost of production in FY19. As a result, we expect EBITDA to rise by 1.1% in FY19E and by 6.2% in FY20E.

HNDL’s earnings remain firm; pessimism factored in: The rupee depreciation will not have any adverse impact on HNDL’s standalone balance sheet. Novelis’s debt is being serviced by Novelis. As a result, HNDL will only have translational impact on consol Balance Sheet. A USD100/t change in aluminium prices should effect ~5% change in FY20E EBITDA, which indicates that earnings change is less susceptible to aluminium prices. Even on a lower multiple, the current market price factors in aluminium price of US$1,700/t, which we believe restricts any downside to the stock. We reiterate Outperformer rating on the stock with a revised target price of Rs323, valuing India business at 5.5x FY20E EV/EBITDA and Novelis at 6.5x FY20E EV/ EBITDA.