Hindalco dip is a chance to buy

Despite recent fall in aluminium prices, expected improvement in profitability and debt reduction keep Street bullish

US-based global aluminium major Alcoa’s September quarter performance and forecast has led to some disappointment. So has the recent $30-40 a tonne fall in aluminium prices at the London Metal Exchange (LME).

Not surprising, then, that the Hindalco Industries' stock, trading near a 52-week high of Rs 164.70, is also down. It has dipped over the pat five trading sessions by six per cent, to Rs 151.

Alcoa’s performance was lower than the consensus estimate, with Ebitda (earnings before interest, tax, depreciation and amortisation) at $683 million (Rs 4,554 crore), compared to the consensus estimate of $727 mn (Rs 4,847 crore). It had also lowered its aluminium deficit forecast to 615,000 tonnes in this calendar year (CY16) from 775,000 tonnes earlier.

On the positive side, it has maintained the demand growth estimate, at five per cent year-on-year in CY16. Alcoa’s performance and expectation is a key indicator for the global aluminium industry, with a bearing for Hindalco and its US subsidiary, Novelis.

The other positive is that are the adjusted EBITDA per tonne of the global rolled segment for Alcoa (comparable to Novelis) was up 7 per cent year-on-year to $354, led by 6 per cent year-on-year increase in sales volumes and higher sale of the high-margin auto sheet segment (up 49 per cent year-on-year), say analysts who are confident on Novelis’s growth momentum continuing.

Analysts at Elara Capital say that with higher overall demand growth in auto, Novelis too will improve profitability at least for next few years. They have assumed 2.5 per cent volume growth in FY17 to 3.2 MT and retained their FY17 and FY18 EBITDA numbers for Novelis post Alcoa’s results. Hindalco also continues benefitting from improved aluminium prices.

The average per tonne aluminium prices during December’15 quarter had declined 24 per cent year-on-year to $1,495, however it has gradually improved up averaging $1,619 in September’16 quarter. While it has corrected from $1,690 levels recently, aluminium prices are expected to move up in the near-term.

What’s more, the company has completed most of its India-based expansions and its profitability is improving. Hindalco had seen its EBITDA per tonne grew 16 per cent year-on-year to $626 for its domestic operations in June’16 quarter despite aluminium prices being 11 per cent lower. With better profitability and better cash flows, the debt is also likely to get reduced.

Analysts at Motilal Oswal Securities (MOSL) estimate Hindalco to generate free cash flows (pre-interest and post capital expenditure) of Rs 8,500 crore and Rs 9,400 crore in FY17 and FY18 respectively. And hence, its net debt is estimated to decline from Rs 55,300 crore in FY16 to Rs 46,800 crore in FY18, driving equity value higher.

For the September quarter, though total aluminium (including premium over benchmark prices) and copper prices on the LME are two and nine per cent down year-on-year, with a surge in aluminium volumes (up about 12 per cent) analyst expect Hindalco’s revenues coming at comparable levels or marginally higher for domestic operations. Operating profit (Ebitda) helped by better cost structure is seeing growing significantly (up 83 per cent year-on-year, as per Reliance Securities estimates).

The company, post June quarter results, had said that going forward better control over power cost along with low cost alumina (primary input to produce aluminium) certainly enhances its cost competitiveness. The captive coal usage is also improving. These along with better operating performance should boost net profit for Indian operations.

At the standalone level, MOSL estimates Hindalco’s net profit (adjusted for one-off items) to surge 264 per cent to Rs 328 crore and consolidated profit by 54 per cent to Rs 895 crore, on a year-on-year basis, in September quarter.

Given the firm prospects for domestic and Novelis’ operations, most analysts remain positive on the stock. Despite the 55 per cent returns (which factor in many positives) in 2016, they see more gains ahead. Analysts at MOSL have given target price of Rs 245, while Religare Research’s at Rs 190 (in their Q2 results preview) still indicates potential upside of over 25 per cent.