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Novelis margins continue to improve

We raise HNDL’s FY22/FY23 EBITDA estimate by 17%/10%

* The 4QFY21 result of Hindalco (HNDL)’s subsidiary Novelis highlights the inherent strength in the business as its margin continues to record new high every quarter. Adj. EBITDA grew 43% YoY to USD505m (7% above est.), driven by the highest ever margin of USD514/t (est. USD493/t).

* Novelis should see mix improvement in FY22 as share of auto volumes should increase on strong demand as well as capacity addition.

* We raise our consolidated FY22E/FY23E EBITDA by 17%/10%, factoring in improved margin for Novelis, and higher aluminum price assumption (+15%/5% to USD2,250/2,100 per ton for FY22/FY23). Reiterate Buy.

Novelis’ 4QFY21 EBITDA surprises on strong volumes and margin

* Revenue / adj. EBITDA / PAT was up 33%/43%/179% YoY to USD3,631m/USD505m/USD176m and came in 1%/7%/19% above our estimate – led by higher-than-expected volumes and margins.

* Volume grew 5% QoQ to 983kt (est 958kt) due to demand improvement. On a YoY basis, it grew ~21% YoY due to Aleris acquisition. The acquired Aleris business reported EBITDA of USD60m in 4QFY21 (USD200m in FY21).

* Adj. EBITDA/t at USD514/t (+3% QoQ / +19% YoY) is the highest ever and was 4% above our expectation of USD493/t. This includes a synergy run-rate of USD20/t (USD79m) from the Aleris integration.

* FCF post capex of USD152m stood at USD409m in 4Q. Over FY21, it generated FCF of USD740m (v/s USD384m in FY20) and incurred capex of USD485m (USD610m in FY20).

* The company has repaid debt of USD2.0b since 1QFY21 (peak gross debt of USD8.0b). Net debt declined by USD379m QoQ to USD4.96b.

* Net debt/EBITDA fell to 2.9x (from 3.8x post the Aleris acquisition in Apr’20).

* FY21 rev / adj EBITDA / adj PAT stood at USD12.3b/USD1.69b/USD0.65b, +9%/+17%/-1% YoY on the back of 9% volume growth to 3.58mt (due to the Aleris integration). Full-year adj EBITDA/t stood at USD471 (+17% YoY).

Key highlights – deleveraging to accelerate going forward

* EBITDA guidance raised: The management guided for EBITDA of >USD500/t in 1QFY22. The same is likely to improve further in the coming quarters owing to an increase in the share of Auto in the mix. The sustainable EBITDA guidance earlier stood in the range of USD475–500/t.

* Introduced cash repatriation policy: Novelis would repatriate USD100m to Hindalco (parent company) in 2QFY22. Also, the Novelis board has decided to repatriate 8–10% of free cashflows before the growth capex annually.

* Share of Auto to rise in mix: Auto volume share in 4QFY21 stood at 19% (16% in FY21). The share of Auto is likely to go up in FY22 with the commissioning of 300kt automotive finishing capacity.

* Capex guidance: Novelis would spend ~USD1.5b towards organic growth. Maintenance capex is guided at USD300m per annum for the next five years. FY22 capex guidance is at USD600–700m (USD485m in FY21).

* Beverage Can demand is expected to grow 3–6% YoY in CY21. On the other hand, the Automotive market is expected to grow 25–30% YoY in CY21, with broad-based volume recovery across geographies.

Valuation and view

* HNDL is our preferred non-ferrous pick owing to its (a) robust volume recovery in both India and Novelis, (b) strong profitability in the primary Aluminum business – given its low-cost integrated aluminum operations in India (in the top quartile globally) and higher LME, (c) solid FCF generation, which should reduce leverage sharply, and (d) reasonable valuation.

* The outlook for Novelis is positive due to resilience in the Beverage Can business and recovery in Auto demand (a high-margin business). Moreover, with better cost control and accruing synergies from Aleris, we expect Novelis’ business margins to remain strong at USD500+/t.

* With ~65% EBITDA contribution now coming from the non-LME business (Novelis), we also see relatively higher stability in HNDL’s earnings.

* While we expect aluminum prices to sustain on the back of improved demand recovery, high inventory at LME and the fear of production cuts in China pose risk to aluminum prices. We factor in LME of USD2,300/t in FY22E and USD2,100/t in FY23E. A USD100/t change in aluminum prices impacts HNDL’s FY23E EPS by 6% and our TP by 5%.

* The stock trades at 5.6x EV/EBITDA and 8.8x P/E on FY22E. We value it at INR480/share on an SOTP basis. Reiterate Buy.

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