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Aluminium smelter expansion is last in priority

Hindalco management was categorical in underlining that 1/2 quarters of high LME doesn’t impact strategy of creating more and more de-risked downstream assets as a part of portfolio. India capex of ~ US$1.1bn over the course of next 5 years of which US$650mn was targeted for augmenting finishing/ extrusion/ FRP/ recycling assets in Aluminium stay the course.

Smelter expansion is relegated to last in priority unless i) domestic power costs become competitive globally and ii) Aluminium prices staying higher for longer can be ascertained. Q4FY21 India EBITDA surprised on the back of better volume performance in Aluminium and Copper, as well as higher value added mix in both. The single minded focus on downstream, ensures that the RoE improvement for Hindalco can only accelerate in the coming year. We upgrade Hindalco to BUY from HOLD with a revised target price of Rs476 (from Rs417 earlier)

* Net debt has reduced by Rs 64bn QoQ.

ND/TTM conso EBITDA at 2.6x. Of US$1090mn of domestic capex scheduled for next 5 years, Hindalco plans to spend Rs27bn in FY22 (against Rs16bn YoY). Net debt increased by ~ Rs 80bn YoY. Higher commodity prices will lead to higher working capital requirement and may lead to higher ND/EBITDA numbers for Q1FY22E.

* Aluminium sales surprised at 329kte (expected 315 kte).

Higher value added sales lead to higher realized premium; higher costs though didn’t allow for the integrated spreads to increase – margin increase at US$102/te QoQ was in line with LME (adj. for hedges) and MJP growth QoQ. Higher domestic sales (50% of the mix) and higher value added sales (at 28% of the mix) drove higher premium realisation. Significantly high linkage mix of 93% helped power costs – normalisation (back to 75%) is expected in Q1FY22.

* Copper EBITDA surprised despite a muted TcRc.

Low TcRc is manifesting in sharp decline in premiums realized. Copper EBITDA fell by only US$30/te QoQ, partly shielded by an increase in copper sales – up nearly 47% QoQ to 107kte. Q1FY22 performance will be impacted by low demand and lower rod sales – higher copper prices being partly responsible.

* Reinforces that upstream capex is last in priority; upgrade to BUY.

The cost of power in India not being competitive compared to hydro power driven/Chinese smelters, the ESG headwinds behind setting up a coal based power plant and the volatility of LME despite Chinese Aluminium cuts are some of the reasons for the relegated priority of smelter expansion. Only with sustained Aluminium prices at higher levels over couple of years, and certainty of competitive domestic power prices will allow management to seriously contemplate smelter expansion. This shows commitment to 5 year strategic vision i.e. downstream organic expansion, deleveraging and shareholder return – in that order. We upgrade to BUY, as the commitment, will ensure a steady increase in RoE and P/B.

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