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Beyond the recent volatility – secular uptrend intact

Aluminium price has been trending higher in CY22 on account of tight supply due to power shortages and rising costs of raw materials. Base case deficit for 2022 (pre Russia-Ukraine war) was expected at 1.5 mn tons (source: Norsk Hydro Investor presentation 4QCY21) which may increase to ~3 mn tons factoring high risk smelter curtailment. Aluminium prices further rose due to Russia’s invasion of Ukraine which resulted in supply chain disruption and uncertainty around Russian exports (2nd largest exporter). Aluminium prices recently touched all time high of US$ 3.9k/t and have since settled at levels of US$3.4k/t spot (JMfe ~US$2.7k/t). We believe current elevated levels are likely to sustain given 1) uncertainty around Russian exports amidst sanctions and exclusion of several Russian banks from SWIFT payment system 2) higher energy costs in Europe due to increased dependence on Russia for energy needs and 3) multi-year low LME inventory which stands at 0.75 mn tons. Scrap spreads have also increased 75% YoY to all-time highs in March’22 (+9% MoM). Demand environment looks robust as can makers and sheet producers continue to witness strong demand. Ball Corporation shared a robust outlook and mentioned that demand for aluminium beverage cans continues to outpace supply. Demand in cans/packaging is expected to offset the hiccups faced in ABS segment. Indian aluminium producers are relatively better placed as energy requirements are met through coal-based captive power plants, with majority of coal being sourced through linkage / captive mines (market sourcing ~33% currently). The outlook for Hindalco remains buoyant given a) Novelis – strong LME-scrap spreads continue b) India aluminium continues to benefit from high realisations c) enhanced coal security post addition of Meenakshi and Chakla coal mines and d) strong FCF generation and focus on de-leveraging (short term WC requirements to increase) to contain net debt/EBITDA. We forecast a net debt/EBITDA reduction from 2.9x in FY21 to 1.0x in FY24E, given strong FCF generation. Hindalco, given ~75%+ steady/strong EBITDA being non-LME linked remains our preferred play in the metal space. Maintain BUY with a SOTP price target of INR690/sh.

Scrap spread at all-time high levels – augurs well for Novelis: Aluminium prices have outperformed scrap prices recently, augmenting spreads and in turn margins for Novelis. Scrap spreads on spot basis are at ~USD1.3k/t, up 75% YoY and (+9% MoM). Scrap spreads form a significant portion of Novelis margins and higher spreads suggest strong sequential margin. Demand environment looks robust as can makers and sheet producers continue to witness strong demand. Ball Corporation shared a robust outlook and mentioned that demand for aluminium beverage cans continues to outpace supply

Aluminium LME prices continue to remain strong: Aluminium price has been trending higher in CY22 on account of tight supply due to power shortages and rising costs of raw materials. Base case deficit for 2022 (pre Russia-Ukraine war) was expected at 1.5 mn tons (source: Norsk Hydro Investor presentation 4QCY21) which may increase to ~3 mn tons factoring high risk smelter curtailment. Aluminium prices further rose due to Russia’s invasion of Ukraine which resulted in supply chain disruption and uncertainty around Russian exports (2nd largest exporter). Aluminium prices recently touched all time high of US$ 3.9k/t and have since settled at levels of US$3.4k/t spot (JMFE ~US$2.7k/t). We believe current elevated levels are likely to sustain given 1) uncertainty around Russian exports amidst sanctions and exclusion of several Russian banks from SWIFT payment system 2) higher energy costs in Europe due to increased dependence on Russia for energy needs and 3) multi-year low LME inventory which stands at 0.75 mn tons

Enhanced coal security: Hindalco enhanced its coal security by winning Meenakshi and Chakla coal mines in recent auctions. These mines have reserves of 285 mn tons/76 mn tons and peak rate capacity of 12/5.3 mtpa. Annual requirement of ~16 mn tons is met through linkages with Coal India (~9 mn tons offtake), captive mines (~2 mn tons) and eauctions (~5 mn tons). E-auctions prices likely to trend higher on the back of strong demand. Coal India’s recent e-auction witnessed 100% booking of quantity offered.

Hindalco well placed to benefit from high aluminium prices: The outlook remains buoyant given a) Novelis – strong LME-scrap spreads continue b) India aluminium continues to benefit from high realisations c) enhanced coal security post addition of Meenakshi and Chakla coal mines and d) strong FCF generation and focus on de-leveraging (short term WC requirements to increase) to contain net debt/EBITDA. We forecast a net debt/EBITDA reduction from 2.9x in FY21 to 1.0x in FY24E, given strong FCF generation. Hindalco, given its ~75%+ steady/strong EBITDA being non-LME linked remains our preferred play in the metal space. Maintain BUY with a SOTP price target of INR690/sh.

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