Hindalco sees stellar gains in FY17 on better business, price rebound : 3 Apr 2017

HINDALCO11

Hindalco saw its stock price grow 2.25 times during the last one year (FY17) as overall business prospects saw substantial improvement. With base metal prices rebounding from lows, completion of capacity expansions, improving domestic profitability as well as that of Novelis (its US subsidiary) has led improvement in cash flow and consequently improving prospects of debt reduction.

Last month was marked by fund raising through QIP, where Hindalco raised Rs 3,350 crore leading to a stronger balance sheet that will help reduce debt further. The next round of downstream capacity expansions will further boost profitability. Thus, in spite of fresh equity being issued, led by the fund raising, and subsequently dilution in earnings per share, analysts have raised their target prices for the stock now trading at Rs 195 levels.

As business segments continue seeing benefits, debt reduction is what is being looked at to provide further triggers. Following successful bond refinancing during the second quarter, Novelis refinanced its $1.8 billion term loan with Asian banks in January which will accrue benefits on interest costs moving forward.

Novelis has already revised its free cash flow guidance to $350 million from $300 earlier. Also, Hindalco plans to repay $1 billion debt with the QIP proceeds using part of its existing cash too, say analysts at CLSA, who thereby see FY18-end net debt-to-equity declining from 1.2 times to 1.0 times, while net debt to Ebitda will drop from 3.7 times to 3.5 times post-QIP.

All this is also to help the company get better credit ratings, allowing fresh loans replacing earlier costlier loans. This coupled with recent debt refinancing by Novelis, leads CLSA see 18 per cent decline in interest costs for the company over FY17-18.

After completing major capacity expansions, the company is now planning downstream expansions that will accrue benefits. These will help Hindalco increase contributions of value-added products to overall sales. The third copper rod plant at Dahej in Gujarat is planned to be completed in about a year which will raise copper rod capacity to 90 per cent of cathode capacity (currently 50 per cent) over next 12 months, which should boost
copper margins.

Also, the company is increasing its alumina capacity at Utkal through de-bottlenecking from 1.5 million tonnes per annum (mtpa) to 2.1 mtpa in about 18 months. Though there will be capex incurred on expansions, benefits to Ebitda will be much larger. Analysts at CLSA, estimate that against total capex of Rs 3,900 crore, the total incremental Ebitda will be Rs 1,100-1,200 crore, making these high-ROCE projects (Return on capital employed 25
per cent).

Further, analysts say that implementation of GST (goods and services tax) wild help reduce logistic costs, as will the new rail links and eastern corridor rail links.

Meanwhile, the costs of production is rising internationally as raw material prices move up. Hindalco, however, has some advantage on captive supplies and its costs are significantly insulated. This will also prove to be an advantage for the company.

Analysts at Jefferies believe Hindalco should benefit from rising cost at Chinese smelters, as it sets a higher floor on prices, while Hindalco’s costs are resilient.

With all these benefits to accrue, analysts at Jefferies say that equity offering overhang is behind us and deleveraging should continue as they estimate net debt to fall to Rs 44,600 crore (Rs 54,900 crore at the end of December’16 quarter) and net gearing to decline to 0.9 times in FY18.
Taking into consideration fresh equity post QIP, analysts at CLSA still have raised their target price from Rs 210 to Rs 230, while Jefferies has raised it to Rs 226.

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