Broking firm, Motilal Oswal has reiterated a buy on the stock of Hindalco, with a price target of Rs 175 per share, as against the current market price of Rs 124.
"Hindalco (HNDL) has corrected 40% in CY20 due to the double whammy of weaker aluminum demand and margins on account of the COVID-19 pandemic and higher leverage owing to Aleris' acquisition.
We believe the correction is overdone and reiterate our Buy rating based on: (1) strength in Novelis' beverage can business where volumes should not be much impacted from COVID-19, (2) long-dated debt maturity profile and ample liquidity in hand (~USD2b), which should help HNDL tide over the current crisis comfortably, (3) consistent free cash flow generation (even in FY21), which should aid deleveraging, and (4) attractive valuation with the stock trading at 0.7x Adj. P/B value and 5.3x FY22E EV/EBITDA. Here are a few highlights from the Motilal Oswal Research report.
1. Novelis – Beverage cans resilient, but weak auto sector to impact EBITDA
Beverage cans constitute nearly two-third of volumes for Novelis (ex-Aleris), which has not seen much impact from COVID-19 due to strong at-home consumption trend. Novelis' auto finishing lines that constitute ~20% of its volumes, however, have been impacted as its auto customers are either shut or operating at low production levels.
"With weak outlook for automotive, we have built in sharply lower volumes for Novelis in FY21 in this segment. This would also impact blended margin as auto is a high margin business. As a result, we expect Novelis' volumes to decline by 10% YoY and EBITDA per ton to fall by 14% YoY to USD380/t in FY21, leading to a 23% YoY fall in FY21E EBITDA to USD1.1b. We expect both volumes and margins to recover in FY22E as auto sales normalize driving an expected 17% YoY EBITDA growth," the .Motilal Oswal Research report says.
2. Lower LME to impact profitability of Indian operations
Due to demand concerns on account of COVID-19, LME Aluminum has declined by 15% YTDCY20 to USD1,450/t and hit fresh 10-year lows (USD1,422/t). Lower LME has a direct adverse impact on HNDL's Indian operations, which is a commodity aluminum supplier. While cost benefits (lower energy cost, higher linkage coal supply, lower caustic soda cost, etc.) should help partly cushion the impact on margin, we still estimate India EBITDA to decline 26% YoY in FY21 due to lower volumes and LME price.
"We also expect LME to improve gradually from current 10-year lows due to supply curtailments and average USD1,575/t in FY21 and USD1700/t in FY22E. At current LME prices, >10% of the global smelters are operating at cash losses, which we believe is unsustainable and would result in supply curtailments bringing market balance. Moreover, hedged LME positions (19% volumes for FY21 hedged at a higher level of USD1,836/t) imply hedge premium of USD56/t in FY21E. We estimate India EBITDA per ton at USD308/t in FY21E and USD383/t in FY22E," the research report has noted.
3. Hit to SOTP from Aleris’ acquisition priced in
"We estimate an adverse impact of INR33/share on HNDL's SOTP from the Aleris acquisition, based on 6.0x FY22E EV/EBITDA. Though the Aleris acquisition gives HNDL a meaningful presence in the lucrative aerospace business, it has happened at an inopportune time as aerospace has been impacted by COVID-19 and Max-737 issues for Aleris' key customer Boeing. We estimate EBITDA of USD210/USD250m (ex-Duffel) in FY21/22E, which makes the deal valuation look expensive at 11.7x/ 9.9x FY21E/FY22E EV/EBITDA. However, given the sharp correction in HNDL's stock price, we believe this adverse impact on SOTP is already priced in," the brokerage firm has noted.
4. Net debt has peaked, FCF to drive deleveraging
With the acquisition of Aleris for USD2.8b (USD2.5b net of Duffel plant sale), HNDL's net debt has increased to ~USD7.8b, implying 4.5x net debt/ EBITDA. We expect net debt to decline to USD7.6/USD7.2b by Mar'21/Mar'22E aided by FCF generation even in a weak economic environment.
We estimate net debt to EBITDA to decline to 3.5x in FY22E as the global economy recovers from the impact of COVID-19. Moreover, HNDL does not have any debt repayments scheduled in FY21, which coupled with the USD2b cash and cash equivalents at its disposal, should help it comfortably tide over the current crisis.
5. Valuation and view
HNDL's share of commodity business has declined to 25% post the Aleris acquisition with the higher margin converter business accounting for 75% of EBITDA.
"We expect the COVID-19 impact to ease in FY22E. Also, we forecast FY22E EBITDA to rise 23% YoY to INR159b (nearly same as FY20 ex-Aleris). We value HNDL on SOTP based on FY22 EV/EBITDA of 5.0x to India operations (commodity business), 6.0x to Novelis (high margin converter business) and 6.0x to Aleris. We also add HNDL's investment in listed market securities at 10% discount to the market price. Accordingly, we arrive at a target price of INR175/share. The stock trades at an attractive valuation of 5.3x EV/EBITDA and 6.9x P/E on FY22E. Reiterate Buy." Motilal Oswal has said in its report.
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