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Transient headwinds; macro picture intact

Novelis’ Q2FY23 EBITDA (adj.) of US$506mn (down 8% YoY) was impacted by cost headwinds, despite growth in shipments. Key takeaways: 1) Double-digit growth in aerospace/automotive shipments while beverage can growth was impacted by destocking; 2) positive impact of favourable product mix was nearly offset by higher cost; 3) FY23 capex guidance trimmed in line with expected cashflow; 4) all announced capex projects are on track with ground breaking 600ktpa Bay Minitte Greenfield rolling mill done in Oct-22. Going ahead, despite near term cost headwinds of US$75-125/te from energy inflation and unfavourable metal price lag, we expect EBITDA to spring back to sustainable guidance of US$525/te as re-negotiated contracts ensure pass-through of higher cost. Besides, strong free cashflow generation in H2FY23- mainly due to working capital unlocking- is a key plus. Taking cues from Novelis Q2FY23 result, we remain positive on Hindalco. Factoring in near-term headwinds and adverse macro operating environment, we value Hindalco at 5.7x FY24EV/EBITDA (midcycle level). Our TP works out to Rs515. We re-initiate coverage on the stock with BUY rating.

* Good performance despite sustained cost headwinds. Novelis’ EBITDA (adj.)/t of US$514 (down 10% YoY) was impacted by inflated energy cost, unfavourable metal price lag and currency impact. Key highlights: 1) Sales volume rose 2% YoY at 984kte on higher aerospace/automotive shipments though beverage can shipments rose only slightly due to customer destocking; 2) cashflow from operations (post capex) was US$(18)mn despite some working capital unlocking owing to lower EBITDA and ongoing capex; and 3) among regions, Latin America’s EBITDA/te contracted the most (down 25% YoY) owing to tight scrap supply apart from energy inflation, while Asia’s EBITDA/te rose 16% YoY on higher can shipments and better product mix (due to higher aerospace shipments). Going ahead, management has guided for near term cost headwinds of US$75-125/te on acute energy inflation and adverse metal price lag owing to lower LME aluminium price.

* Positives in sight despite near-term jitters. In our view, earnings over the medium term may be aided by 1) re-negotiated contracts (Jan-23 onwards) to ensure pass-through of cost; 2) energy cost in Europe hedged to the extent of 80% in H2FY23 and 60% in FY24; and 3) significant free cashflow generation of US$500mn in FY23. Our FY23E/FY24E EBITDA/te of US$490/US$500 reflects near term cost headwinds.

* Outlook: Short-term pain; long-term gain. In near term, we see positive result from working capital unlocking despite constrained earnings while long-term outlook remains positive. We re-initiate coverage on Hindalco with BUY rating and TP of Rs515 on 5.7x FY24EV/EBITDA

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