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Focus on downstream remains key to value creation

Higher working capital requirement created a road bump in the declining debt trajectory, given the converter nature of Copper India and Novelis for Q1FY22. Q2FY22 performance was better than expected with net debt reducing ~Rs39bn QoQ. EBITDA performance was also much better than expected with reported consolidated EBITDA at Rs75bn as against Rs69bn expected. The surprise has been driven by the Aluminium operations on the back of better-than-expected premiums. Cost performance for the quarter was as guided before (up 5% QoQ). Management continues to focus on downstream execution with value-added mix expected to double over the next 3-5 years (from 35-40% of the current product mix). There were mentions of incremental hot mill capex in Novelis in the call, more details will emerge later. The strategic vibes remain as consistent as ever. We maintain BUY on Hindalco with an unchanged target price of Rs550/share.

* Standalone (Aluminium with ~50% Alumina integration) margins are still strong at US$1000+/te. This has been helped with a moderate increase in power costs and very high premiums. Premiums surprised us as VAP sales as % of total sales have declined QoQ. Also, domestic sales proportion have increased 4pps from 44% to 48% QoQ. VAP sales, after touching all time high 28% in Q4FY21 have been coming off. We expect a sharp reduction in this standalone EBITDA/te over the next two quarters. However, integrated spreads may still be maintained as elevated Alumina prices along with higher volumes pull up the print in H2FY22. As per management (and as per our assessment), there is not much spread to be made by unintegrated (alumina+power) smelters now. This doesn’t gel with the integrated EBITDA/te print that Hindalco is reporting now or expected to report over next 2 quarters.

* Key developments in the quarter. 500kte expansion project in Utkal Alumina started commercial production in Q2FY22 and has already achieved rated capacity, taking its total capacity to 2.1mtpa. Hindalco signed a definitive agreement with Polycab to acquire its 100% equity stake in Ryker Base, which has a 225ktpa cast and rolled copper wire rods manufacturing facility.

* Management stays the course on incremental downstream expansion – has previously guided for US$1.1bn of downstream (Aluminium + Copper) India expansion over FY22-25E -- announced 170kte of FRP expansion in Hirakud in Q2FY22. This will most likely be followed by a recycling expansion (Aluminium and copper). We see a steady improvement in standalone business RoE/RoCE as the downstream capacities ramp up. Much to our comfort, management reinstated that upstream expansion is mostly off the management radar. We maintain BUY with a target price of Rs550.

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