"Following a 32 percent underperformance of Hindalco Industries since our initiating coverage report, we continue to retain our Sell recommendation on its stock as we believe the aluminium cycle would remain in downward trajectory for a prolonged period. We also believe that consensus projections have factored in a lot of optimism in respect of aluminium prices and hence the earnings downgrade would continue in FY14 as well (there is 13 percent/14 percent cut in consensus EBITDA estimates for FY13E/FY14E, respectively, over the past one year). We have revised our FY14E EBITDA/PAT estimates downward by 13 percent/15 percent, respectively, due to a reduction in domestic market volume estimates and a change in currency assumption. Our EBITDA estimates are 10 percent/19 percent below consensus estimates for FY14E/FY15E, respectively.
Earnings to remain subdued: We expect just a 2 percent CAGR in consolidated EBITDA over FY12-FY15E, while PAT is likely to witness a negative CAGR of 23 percent over the same period due to high interest costs and depreciation. Standalone performance is likely to witness significant pressure with 9 percent/40 percent drop in EBITDA/PAT, respectively, over FY12-FY15E despite an 8 percent CAGR in aluminium volume. Although Novelis' performance would remain stable in US dollar terms, in rupee terms the performance would be impacted, due to currency appreciation.
Mahan coal block benefits unlikely before FY16: The final lease pact for Mahan coal block in Madhya Pradesh has not yet been signed and we believe it can still take three-six months, taking an optimistic view, considering the slow government clearance process. However, after that it would take 15-18 months to develop the projects, which effectively means the benefits of Mahan coal block would accrue only from FY16.
Structural changes in global aluminium market: There have been a few structural changes in pricing and costs compared to 2005-08, where costs have moved up by USD 400/tn-USD 500/tn while prices have settled in the lower range of USD 400/tn- USD 500/tn over the same period. We don't expect any dramatic change in the scenario considering lower demand and inventory overhang (over three months of inventory). In the above scenario, Hindalco is investing close to Rs400bn (FY13E-FY15E capex is Rs184bn) to expand aluminium capacity three-fold. We expect a low single-digit return ratio from these projects, which could potentially de-rate the stock for a very long period.
Leveraging Novelis' balance sheet seems to be a remote possibility: Considering the large capex in domestic market, leveraging Novelis' balance sheet would have been a prudent strategy to benefit from low interest rates in developed markets. But this option looks to be remote as its free cash flow post capex is negative USD 82mn over FY13E-FY15E and the debt/EBITDA ratio is at optimum level of 5.1x on TTM basis.
Valuation: Hindalco trades at EV/EBITDA multiples of 8.1x/8.3x FY14E/FY15E earnings, respectively, above the past 10 years' average of 5.4x. We have retained Sell rating on it with a revised target price of Rs 75 (4.5x FY15E EV/EBITDA and CWIP at a 20 percent discount)," says Nirmal Bang research report.
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