Novelis booster for Hindalco

Improving profits of Novelis, India operations, and debt reduction, will drive Hindalco's stock valuation

The strong operating performance by Novelis, the US-based subsidiary of Hindalco, lifted street sentiment on Tuesday with Hindalco's share price scaling to its 23-month high of Rs 172.25. This is surprising given that earlier in October some nervousness was seen after US-based global aluminium major Alcoa's operating performance came below estimates. Notably, for Novelis, its improving performance is expected to sustain.

Better product mix and operating efficiencies helped Novelis post 14% year-on-year (y-o-y) increase in Ebitda (earnings before interest, tax, depreciation and amortisation) to $270 million in September 2016 quarter (Q2) — the third consecutive quarter of over $250 million Ebitda. Ebitda per tonne at $350 also jumped 32% y-o-y in Q2.

Though the decline in volumes and thereby revenues may have been a bit disappointing, this can be attributed to Novelis focus on value-added products in light of increasing competition in beverages' Cans segment. Net sales decreased 5% to $2.4 billion, partly due to lower average aluminium prices and 2% decline in total shipments of rolled aluminium products to 773,000 tonnes. Positively, the strategic shift to higher conversion of premium aluminium products (more profitable), including a 12% increase in automotive sheet shipments to record levels, helped offset some of the pressures.

Novelis though reported a net loss of $89 million. But, the same is due to the $112 million loss on extinguishment of debt related to the refinancing of $2.5 billion worth of Senior Notes, which will drive significant interest savings moving forward. Another $27 million loss was booked related to the sale of Aluminium Company of Malaysia, which was a non-core operation. Adjusted for one-offs, net profit at $60 million came much better than $25 million in the year-ago quarter.

With a good operating performance, Novelis management has guided for the higher free cash flow of up to $350 million in FY17 (earlier guidance $250 million). This bodes well for a reduction in debt. On the whole, analysts remain positive on Novelis. Those at Elara Securities say that continued focus on improving product mix will help drive profitability despite lower volumes. Thus, despite lowering their volume estimates, the analysts have retained their Ebitda estimates for FY17 and FY18.

Given the backdrop, analysts at Edelweiss say that probability of Hindalco meeting consensus estimates have also increased. The company's domestic operations are also expected to see improved profitability with higher copper volumes as production from new units stabilises-sequentially too prices have been improving. Most of the capacity expansions have been completed, which coupled with debt reduction and better cash flows should drive earnings. While Motilal Oswal Securities has a target price of Rs 245, Religare's at Rs 190 and its analysts believe Hindalco's deleveraging will drive equity valuations. The company is also reported to be weighing a $500 million rights offer or institutional sale (about 10% of current market cap) to raise funds and further reduce debt.