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Adjusting to new reality – a quarter of shutdown

With the second wave of Covid19 re-emerging in China and India fast moving into a lockdown, a steep cut in earnings of metals pack for FY21E looks likely. We have assumed a quarter of disruption in domestic and Novelis operations for Hindalco. This leads to FY21E EBITDA/PAT reduction of 37% and 75%, respectively. This takes consolidated EBITDA back to CY15 levels (last downturn). We have reduced FY21E Indian Aluminium (integrated) EBITDA by 37% and Novelis EBITDA by 41%. Domestic operations can witness a quarter of negative EBITDA – whenever disruption hits production. Cash position with Hindalco remains comfortable. While we acknowledge the extent of earnings correction possibility, we see deep value in the name purely on the back of our asset-based valuation heuristic (P/B). We maintain BUY with a target price of Rs199/share (equivalent to 0.67x 1-year fwd P/B).

* US auto industry has started witnessing disruptions. Temporary shutdown of US plants by US car manufacturers, can meaningfully impact the auto-sheet market. Aluminium auto sheet market has reached 1.2-1.3mnte in the US, with Novelis supplying ~35% of the same. US auto sheet supply forms a significant chunk of Novelis’ overall auto shipment supplies (650kte) in FY19 and contributed a revenue of US$3bn. Sales to Ford itself was US$1.23bn or 10% of the total Novelis revenue. We estimate these auto volumes (out of US) contribute 22-23% of total Novelis EBITDA (given the high margins) and 13% of consolidated Hindalco EBITDA. We have uniformly pared down volumes and EBITDA estimates across regions for Novelis operations. This results in 41% decline in Novelis EBITDA estimates (this also builds in a drop on account of metal price lag impact).

* FY21E India earnings reduced to factor in a quarter of plant shutdowns across locations. We have factored in ~23% drop in aluminium volumes leading to ~37% drop in integrated aluminium EBITDA for FY21E. This is despite the possible drop in fuel oil, pitch, CP coke, and caustic soda prices. We have also increased receivable days for Hindalco (standalone) – an issue seen for businesses across the spectrum. We are yet to reduce the Indian capex (guided at Rs20bn p.a) but as situation deteriorates there is a possibility for the same.

* Hindalco is enjoying comfortable cash position. India operations have ~Rs70bn while US$1bn is currently available with Novelis. Extra fund raised on account of Aleris acquisition (US$400mn) has helped Novelis liquidity. There is no major immediate refinancing due for Novelis in Q1/Q2FY21. Hence, closure of business activity for a quarter doesn’t reveal any particular vulnerability for Hindalco.

Maintain BUY. Our P/B metric is suggesting deep value for Hindalco as it breaches CY08/CY15 lows with an improved balance sheet and hence, a reduced probability of loss. We maintain BUY with a target price of Rs199/share as we shift our valuation methodology to 0.67x 1-year fwd book – in-line with RoE (through cycle) of 7-8% that we see in the name.

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