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Margin outlook remains strong

We raise HNDL’s FY22/FY23 EBITDA estimate by 3%/7%

* Novelis, Hindalco’s wholly-owned subsidiary, reported record-high adj EBITDA of USD508m (adj for one-off income of USD47m) on the back of record-high margins of USD522/t (+2% QoQ).

* Novelis should see mix improvement in 2HFY22 and FY23 as the share of auto volumes should increase on account of capacity additions.

* We raise our consolidated FY22E/FY23E EBITDA by 3%/6%, factoring in a higher aluminum price assumption (+3%/7% to USD2,375/USD2,300 per tonne for FY22/FY23). Reiterate Buy.

In-line EBITDA; margins strong despite adverse product mix

* Revenue / Adj. EBITDA / PAT was up 59%/101%/116% YoY to USD3,855m/USD508m/USD210m, in line with our estimate. Reported adj EBITDA, however, was higher at USD555m, led by one-off income of USD47m on account of the favorable outcome of tax litigation.

* Volumes were flat (-1% QoQ) at 973kt (est 960kt) due to the seasonality impact and lower demand from Automotive in North America; this was offset by higher volumes from other segments.

* Adj. EBITDA/t stood at a record high of USD522/t (+2% QoQ). However, this was lower than the estimate of USD530/t, as better aluminum scrap spreads were partly offset by a weaker product mix (lower auto volumes). Novelis reported margin improvement for the fourth successive quarter in 1QFY22.

* FCF post capex of USD101m stood at a negative USD30m in 1Q due to higher working capital needs. As a result, net debt was flat QoQ at USD5.0b. Net debt/EBITDA fell to 2.5x (from 3.8x post the Aleris acquisition in Apr’20).

Key highlights from management commentary

* Refinancing to lower interest cost; debt maturity profile comfortable: The company expects annual interest cost savings of USD35m from the refinancing of USD1.5b worth of 5.875% unsecured notes due in 2026. It would also pre-pay a USD524m term loan due in Jun’22 this year. Post this, the company does not have debt repayments due up to FY25-end.

* FCF to be lower in FY22: FCF generation is expected to be lower in FY22 due to higher working capital and capex spend.

* Synergies guidance increased: Novelis achieved a combination synergy runrate of USD100m in 1QFY22 (USD79m in 4QFY21). It now expects combination synergies to exceed its earlier guidance of USD120m. Furthermore, the strategic synergy from the Aleris integration in China would now exceed USD100m (earlier expectation: USD65m).

* China expansion announced: Novelis has finalized its 200ktpa expansion plan in China, entailing capex of USD375m (earlier guided for USD300m) over the next three years.

* Duffel receivables impaired by USD63m: The company has written down receivables of USD63m from the Duffel transaction to a fair value of USD45m. It now expects to settle the receivables with Avalance (buyer) outside the courts for USD45m as it believes arbitration proceedings would take time and reduce management bandwidth.

Valuation and view

* Hindalco (HNDL) is our preferred non-ferrous pick owing to a) robust volume recovery in both India and Novelis, b) strong profitability in its primary Aluminum business, given its low-cost integrated operations in India (in the top quartile globally) and higher LME prices, c) solid FCF generation, which should reduce leverage sharply, and d) reasonable valuations.

* The outlook for Novelis is positive due to its resilience in the Beverage Can business and demand recovery in Auto (a high-margin business). With better cost control, higher scrap spreads, and accruing synergies from Aleris, we expect Novelis’ business margins to remain strong at over USD500/t.

* With ~65% EBITDA contribution now accruing from the non-LME business (Novelis), we see relatively higher stability in HNDL’s earnings.

* Given tight demand-supply, we expect aluminum prices to remain strong. We raise our LME price assumption by 3%/7% to USD2,375/USD2,300 per tonne in FY22E/FY23E. A USD100/t change in aluminum prices impacts HNDL’s FY23E EPS by 5% and our TP by 4%.

* The stock trades at 5.2x EV/EBITDA and 8.7x P/E on FY22E. We value HNDL at INR520/share on an SoTP basis. Reiterate Buy.

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