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Saturation of an earnings lever

Novelis reported an inline adjusted EBITDA of US$508mn in Q1FY22 (EBITDA/te of US$522/te). EBITDA was buffered by US$47mn of favourable gain from Brazil tax litigation, resulting in an optical beat. Novelis was categorical in playing down the EBITDA impact from a halt in auto production due to chip shortage – can maintain US$500/te of EBITDA.

Aleris continues to benefit from the constructive building and construction markets. For the last couple of years, Novelis was instrumental in providing a steady tailwind to Hindalco’s EBITDA as i) scrap LME spreads expanded ii) Aleris acquisition coincided with specialties taking support of a strong building and construction markets as well as higher scrap LME spread and iii) Latin American spreads rebased to US$800/te+. With most of the volume and margin upsides, from Novelis, in the estimates, the story of Hindalco will pivot back to LME and its volatilities. We maintain BUY with a revised target of Rs510 (Rs476 earlier)

* 4.5mtpa volumes factored in for FY23E. Novelis has increased global automotive capacity to ~1mnte. 200kte of Greenfield expansion in Kentucky, US and 100kte brownfield expansion in Changzhou, China is under commissioning. China is expected to ramp up in next 1.5 years, while US will take few years for full utilisation. Brazil 100kte rolling and recycling expansion is broadly on track and started commissioning in Q2FY22. The facility has cast first ingot in remelt area in July, ’21. Novelis has also increased China capex (3 years) to US$375mn while planning to fully integrate automotive business in Asia. Also, plans to unlock capacity in UAL to serve growing Specialty and Can business.

* Aleris acquisition integration update. Novelis achieved US$100mn in run-rate combination cost synergies through Q1FY22. Management increased total synergies forecast above US$220mn i) Strategic synergies will exceed US$100mn ii) Combination cost synergies will exceed US$120mn. Bothe the run-rate combination synergies as well as synergy forecast has been moving up every quarter for the past three quarters – hopefully the increase hasn’t been driven by scrap-LME spreads. Runrate actuals for synergies went up from US$54mn in Q3FY21 to US$100mn in Q1FY22, while projected synergies have moved up from US$185mn to US$220mn in the same period. Capex in China (Zhenjiang) has been increased in Q1FY22 to US$375mn (US$300mn previously). The idea remains to expand Zhenjiang to produce automotive cold coils to feed Changzhou CASH lines (along with automotive casting house, recycling capability, hot mill upgrade).

* Maintain BUY. As we look ahead in FY22/23E, we see limited earnings tailwind from Novelis (vis-à-vis expectations). From here on, with a FY23E LME assumption of US$2200/te, RoE of 14% and attributed P/B of 1.3x, we maintain BUY with a target of Rs 510 share. Novelis as an earnings trigger is largely exhausted in our view, allowing the LME induced volatilities to drive share price performance.

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