Rising LME and improving demand positive
Beverage Can demand remains resilient, Automotive improving Hindalco (HNDL)’s global peers Constellium, Norsk Hydro, and Crown Holdings reported their 2QCY20 results recently. A read-through of these indicated a positive outlook for near-term volumes and margins at Novelis (HNDL’s overseas business).
* In 2QCY20, volumes declined by ~10% YoY in Beverage Can (weakness in Latin America and Europe), ~55% YoY in Automotive, and ~40% in Aerospace. However, demand is improving, with volumes in 3QCY20 guided to be much better.
* The Beverage Can market remained strong in North America, with volume growth even in 2QCY20. Conversely, the European Can market witnessed decline due to weakness in Southern Europe. South America also witnessed decline due to lockdown in April; however, demand rebounded sharply mid-May onward.
* Constellium informed that its capacity utilization in Automotive has now reached 80% on account of improving demand, although the outlook remains uncertain.
* Post the Aleris merger, segmental contribution to Novelis’ volumes stands at: ~50% from Beverage Can, ~20% from Automotive, and ~4% from Aerospace. The balance ~26% comes from Speciality, Building & Construction, and Truck Trailers.
* Implied volume decline in Novelis in 2QCY20 (1QFY21) from previously reported industry trends amounts to ~20% YoY, in line with our estimate.
* Also, Constellium reported receiving EUR15m aid (implied EUR50/t of vol.) from European State Employment in 2QCY20 in the wake of the COVID-19 outbreak. This led to EBITDA/t from the Packaging and Automotive segments declining just 6% YoY to EUR262/t, even as volumes declined 23% YoY. On the other hand, EBITDA/t for Aerospace and Transport (A&T) declined 32% YoY to EUR691/t, with 28% YoY decline posted in volumes.
* Moreover, spot London Metal Exchange (LME) Aluminum prices recovered ~16% from recent lows of USD1,422/t to USD1,655/t (currently), led by higher demand in China as well as a weakening DXY (US Dollar Index). This should benefit HNDL’s Indian business (~30% of consol. EBITDA), a key producer and supplier of primary aluminum.
Valuation and view
* Hindalco (HNDL) remains our preferred non-ferrous pick owing to: 1) its resilience in the Beverage Can business, 2) improving Aluminum business profitability from declining costs and improving LME, 3) its long-dated maturity profile, 4) consistent FCF generation and 5) reasonable valuation.
* With 70–75% EBITDA contribution now coming from the non-LME business (Novelis + Aleris), we also see relatively higher stability in HNDL’s earnings.
* Given HNDL’s low-cost (top quartile globally) integrated aluminum operations in India, we believe it is well-placed to benefit from rising LME.
* We have factored average LME of USD1,590/t in FY21E and USD1,700/t in FY22E. While we expect LME to sustain at current levels, we maintain our LME assumption due to uncertainty.
* The stock trades at 5.6x EV/EBITDA and 9.0x P/E on FY22E, at a ~20% discount to the past 10-year average. We value it at INR198/share on an SOTP basis. Reiterate Buy.
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