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On a firm footing

Strong cash flows to support growth and deleveraging

* In its virtual analyst meet on Feb 22, Hindalco (HNDL) laid out its strategy and capital allocation roadmap for the next five years. While no new capex plans were announced, the focus remains on growing the downstream business in India and deleveraging the balance sheet, supported by strong cash flows in both India and Novelis. Net debt/EBITDA is targeted to fall to 2.5x by Mar’22 (from the peak of 3.8x in Jun’20).

* We reiterate HNDL as our top non-ferrous pick on the back of a 26% EPS CAGR over FY21–23E, driven by strong volumes, margins, and deleveraging. We roll forward our TP to Mar’22 and raise it to INR390.

Focus on organic growth and deleveraging

* The management expects to generate USD1–1.2b annual cash flow post its normal working capital and maintenance capex. It plans to broadly allocate this as follows: a) growth capex – 50%, b) deleveraging – 30%, c) returns to shareholders – 8–10%, and d) balance to be retained in treasury.

* Allocation toward organic growth capex over the next five years is accordingly guided at ~USD2.5–3.0b – ~USD1.5b in Novelis to grow its capacity to >4.5mtpa (from 4mtpa currently) and the balance USD1–1.5b in India to grow its Downstream business. At the same time, it does not plan to entertain any inorganic growth opportunity.

* Out of the post-Aleris acquisition (gross of debt of USD11.1b), HNDL also plans to repay USD2.9b by Dec’22 – USD2.6b in Novelis and USD0.3b in India. Net debt/EBITDA is targeted to fall to 2.5x by Mar’22 (from the peak of 3.8x in Jun’20) – below the pre-Aleris acquisition level of 2.6x in Mar’20.

* HNDL has also revised its dividend distribution policy to now pay out 8– 10% of the consolidated FCF (pre-growth capex). We estimate this to increase the dividend to INR2.5–3/sh from INR1.2/sh in FY20.

Robust business trading at reasonable valuations; Buy

* HNDL is our preferred non-ferrous pick owing to a) its strong profitability in the India Aluminum business from its low-cost integrated operations (top quartile globally), b) a positive outlook for Novelis, driven by recovery in auto demand and cost synergies from Aleris, c) solid FCF generation, which should reduce leverage sharply, and d) reasonable valuations.

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

* Even on our conservative LME aluminum assumption of USD1,850/t, the valuation is attractive at 4.9x FY23 EV/EBITDA. A USD100/t change in aluminum price impacts HNDL’s FY22E EPS by 11% and our TP by 9%.

* We value it at INR390/sh on FY23 EV/EBITDA – 5x for India and 6x for Novelis. Reiterate Buy.

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