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Strong beat on India numbers, costs to peak out in 2Q

* HNDL reported a strong set of 1QFY23 earnings, driven by all round beat on EBITDA. Consolidated revenue grew 40% YoY and 4% QoQ to INR580b during the quarter, 9% ahead of our estimate.

* Consolidated EBITDA rose 37% YoY and 15% QoQ to INR84b. EBITDA was 35% higher than our estimate, driven by beat in the aluminum and copper business. Adjusted EBITDA for Novelis grew 10% YoY and 30% QoQ to USD561m, a 12% beat to our estimate.

* APAT grew 41% YoY (flat QoQ) to INR41b, significantly ahead of our estimate, driven by a sharp beat on EBITDA and aided by higher than estimated other income.

* The management, however, guided at a sharp uptick in costs as higher cost coal procured in May-Jun’22 will be due for consumption in 2QFY23.

* It recently raised its FY23 EBITDA/t guidance for Novelis due to its strong performance in 1Q.

* We raise our consolidated EBITDA by 6%/5% for FY23/FY24 as the management focuses on the downstream aluminum business in India, which will drive margin higher. At the same time, the low-cost alumina from Utkal will continue to drive down costs. Novelis is renewing its existing contracts as and when they are due at a better margin. We raised our SoTP driven TP to INR525 (from INR490 earlier).

Costs likely to peak in 2QFY23

* The management expects the production cost of aluminum to rise in ‘midteens’ on a QoQ basis, driven by higher coal costs, due to non-availability as well as higher prices. We note that the e-auction price for COAL has been conducted at a premium of over 200%, while coal availability for the non-regulatory sector has been slashed to 50% from 75%. Actual delivery has been even lower, as most of the coal has been diverted to power plants.

* The calculated CoP for the aluminum business (including the downstream business) has reduced by 9% QoQ as against the management’s guidance of a hike of ~15%. The management said low-cost inventory in the system has helped offset part of the cost push. This will imply a sharp QoQ jump in total CoP for the India aluminum business in 2QFY23.

* We believe that costs will likely peak out in 2Q, with an improvement in the FSA linkage situation from 3QFY23 onwards, as demand for power peaks out after Diwali. This should result in a reduction in cost for HNDL. We feel captive coal blocks are an option from FY24 onwards in the best case scenario.

Valuation and view

* The full-year EBITDA/t guidance for Novelis, after its 1Q result, implies an EBITDA of USD505/t for 9MFY23, in line with our estimate. Novelis’ management continues to highlight the strong demand for beverage cans as the mainstay for secondary aluminum demand, in addition to rising demand from the Automotive business as semiconductor shortages ease out.

* Novelis’ greenfield capex of USD2.5b, at the management guided ‘mid-teen RoCE’, implies a substantial boost to its EBITDA trajectory over the next threeto-four years.

* The management is focused on the downstream business in India, with the upstream aluminum business at least two years away from an investment decision.

* This implies that most of the capex in India will either be for: a) downstream value addition, or b) investment in renewable energy to continue to reduce its carbon footprint.

* HNDL recently repaid its high-cost bonds of INR60b, priced at 9.6%, which will further reduce its finance cost as this was the most expensive loan on its books.

* We maintain our Buy rating with a SoTP-based revised TP of INR525 (from INR490 earlier). A slowdown in China remains the key risk to our call.

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