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Novelis continues to surprise on margins

Synergies leading to incremental EBITDA

* The 3QFY21 result of Hindalco (HNDL)’s subsidiary Novelis highlights the strong rebound in business performance. Adj. EBITDA grew 39% YoY to USD476m (8% above est.), driven by the highest ever margins of USD510/t (est. USD490/t).

* We raise our consolidated FY21E/FY22E/FY23E PAT estimate by 8%/6%/6%, factoring in strong margins for Novelis. We also expect faster deleveraging as net debt/EBITDA has declined sharply to 3.3x. Reiterate Buy.

Novelis’ 3QFY21 EBITDA surprises on strong volumes and margins

* Revenue / adj. EBITDA / adj. PAT was up 19%/39%/35% YoY to USD3,241m/USD476m/USD197m and came in 2%/ 8%/ 13% above our estimate, led by higher-than-expected volumes and margins. We have excluded the one-time customer obligation income of USD25m in Europe from our analysis.

* Volumes grew 17% YoY to 933kt (+1% QoQ) on record automotive shipments in Asia and higher can sales in South America.

* Adj. EBITDA/t (net of one-off income) at USD510/t (est. USD490/t) is the highest ever reported by Novelis (up 3% QoQ / 19% YoY).

* The acquired Aleris business reported EBITDA of USD50m and volumes of 104kt, implying margins of USD481/t.

* The company achieved a synergy run-rate of USD54m from the Aleris integration in 3Q, which contributed USD14/t to margins.

* Excluding synergies and the Aleris business, Novelis’ like-to-like volumes grew 4% YoY to 829kt. The EBITDA margin also rose 16% YoY to USD498/t.

* FCF post capex stood at USD75m (USD207m in 9MFY21). Capex in 3QFY21 stood at USD107m (USD333m in 9MFY21).

* Novelis’ net debt declined USD250m QoQ to USD5.35b. Net debt/EBITDA has fallen to 3.3x (from 3.8x post the Aleris acquisition in Apr’20).

Key highlights – deleveraging to accelerate going forward

* The company repaid USD500m of the bridge loan due in Apr’22. The management now expects to achieve its target net debt/EBITDA of <3.0x ahead of its guided timeline of Mar’22 (3.3x in Dec’20).

* The management informed that the tightness in aluminum scrap spreads in North America is a short-term phenomenon, and it does not foresee any material impact of the tightness in scrap spreads on margins.

* The management does not foresee any impact from China allowing imports of aluminum scrap in the near term due to logistical constraints.

* It maintained its guidance of USD475–500/t on a sustainable basis despite achieving higher margins in 3QFY21 – due to near-term uncertainty and volatility on account of COVID.

* The greenfield automotive finishing plant, situated in Guthrie, Kentucky in the US, shipped its first customer coils in December. While, the new automotive finishing line in Changzhou, China is expected to commence commercial production in 4QFY21. The expansion of the recycling, casting, and rolling capacity in Brazil remains on track to be commissioned in mid-FY22.

* Beverage can demand is expected to grow 3–6% YoY in CY21. On the other hand, the Automotive market is expected to grow 25–30% YoY in CY21, with broad-based volume recovery across geographies.

Valuation and view

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

* The outlook for Novelis is positive due to resilience in the Beverage Can business and recovery in Auto demand (a high-margin business). Moreover, with better cost control and accruing synergies from Aleris, we expect margins for the Novelis business to remain strong at USD480+/t.

* With ~75% EBITDA contribution now coming from the non-LME business (Novelis), we also see relatively higher stability in HNDL’s earnings.

* While we expect aluminum prices to sustain on the back of demand recovery, higher inventory could limit a further upside. We factor in average LME of USD1,780/t in FY21E and USD1,850/t in FY22E. A USD100/t change in aluminum impacts HNDL’s FY22E EPS by 11% and our TP by 9%.

* The stock trades at an inexpensive 4.6x EV/EBITDA and 6.1x P/E on FY22E. We value it at INR318/share on an SOTP basis. Reiterate Buy.

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