Hindalco: Novelis brings fresh impetus

Renewal of the Coca-Cola bottlers-Novelis deal and commencement of new domestic capacity should boost volumes.

After touching a 52-week low on January 2, Hindalco shares got a boost, as its US arm, Novelis Inc, renewed its can-body sales agreement with global beverage giant Coca-Cola. Also, the agreement between the two companies, Novelis and Coca-Cola, to dismiss all pending litigation relating to the previous contractual terms acted as a catalyst. The stock, under pressure since February, today jumped nearly six per cent, the most among metal stocks. Novelis had burnt its hands in 2007 with the contract being fixed-price. The case is not the same now, as raw material price volatility has been taken care in the new contract, making Novelis more resistant to volatility at the London Metal Exchange (LME).

On the flip side, the investor sentiment has been impacted due to weak commodity prices on global uncertainty and firm coal and interest costs. Concerns compounded at December-end, as Hindalco failed to get relief from the Bombay High Court on an Income Tax order levying a tax demand. Coal India’s recent move to shift to a new pricing mechanism, which increased fears of costs going up, has only added to its woes.
 

STABLE MARGINS
In Rs crore	FY2011	FY2012E	FY2013E
Net sales	71,801	78,207	82,001
% chg y-o-y	18.60	8.90	4.90
Ebitda	8,002	8,466	9,359
Ebitda (%)	11.10	10.80	11.40
Net profit	2,456	3,188	3,326
% chg y-o-y	-37.40	29.90	4.30
EPS (Rs)	12.80	16.50	17.20
PE (x)	10.10	7.90	7.60
E: Estimates; Consolidated financials Source: CapitaLine, Bloomberg, Analyst reports

The bad news ends there. According to analysts, the tax concerns looked exaggerated. Analysts at Citi, in their report, said the tax liability figure of close to Rs 1,100 crore was erroneous, and their calculations based on the normal guarantee commission rates suggested the charge could be lower at Rs 150-200 crore. The rejection of the writ also does not stop Hindalco from appealing against the order. The analysts continue to prefer the stock in the non-ferrous space, given steady earnings prospects from Novelis and Hindalco’s lower costs.

Resuming supplies
Novelis signed a multi-year agreement with Coca-Cola Bottlers’ Sales & Services Company for supply of aluminium can sheet for the latter’s beverage can producers in North America. Novelis was a supplier to Coca-Cola earlier too.

However, differences cropped up in 2007, after the fixed-price contract forced Novelis to sell can sheets at prices below its costs, which affected its profitability (till 2009). The new contract, however, was positive for Novelis, said analysts. Giriraj Daga at Nirmal Bang Institutional Equities said, “The development is positive and under the new contract, Novelis will remain unaffected from any aluminium price fluctuations.”

Steady business model
With Hindalco as its new owner, Novelis has already started working on cutting cost and improving efficiencies. Novelis now operates on the conversion model, wherein it purchases primary aluminium and converts it into specialised products, all of which has seen its operating performance improve. At $607 million, its adjusted earnings before interest, taxes, depreciation and amortisation (Ebitda) in the first half of this year was in line with 2011-12 guidance of $1.1-1.5 billion. The September quarter Ebitda per tonne touched a high of $418.

Analysts at Emkay Global said in their report that Novelis would continue to deliver strong performance, as it was immune to LME volatility, being cost-effective and having pricing power. While Tarang Bhanushali, analyst at IIFL, said earnings from Novelis would be resilient enough to withstand any global shock and, thereby, give downside support to the stock.

Hindalco: costs may inch up
Hindalco meets around 30 per cent of its coal requirements from captive sources. Fifty per cent is procured from Coal India through linkages and the rest from e-auction. With Coal India changing to the gross calorific value-based pricing, analysts feel it is too early to ascertain the impact, as the company already pays a premium of 60-65 per cent on coal for the Renukoot smelter (which accounts for 70 per cent of output). Analysts at Citi estimate the linkage coal costs may rise four to five per cent.

Cushion for metal prices
After dipping below $2,000 a tonne, LME aluminium prices are lightly above that mark. Since the average cost of production (globally) is about $2,000, any decline below it would trigger a significant cut in global production, providing support to prices. Thus, Bhanushali has revised the average aluminium price estimates for 2011-12 to $2,310/tonne.

The impact on Hindalco may not be high. Bhanushali said while producers in other countries had seen 10-15 per cent fall in revenues, domestic producers like Hindalco would see only one-three per cent fall on the back of rupee depreciation. The rupee depreciation is also likely to have a positive impact on copper treatment and refining charges generally payable in dollars.

Hindalco is in the process of raising its 500,000 tonnes per annum (tpa) aluminium smelter capacity to 1.5 mtpa by 2016. Its 359,000-tpa new capacity and a 900-Mw power plant at Mahan (Madhya Pradesh) are ready for commissioning. Though its captive Mahan coal block is awaiting forest clearance, the company hopes to meet its requirement through imports in the interim. While this project should boost volumes in 2012-13, its Utkal alumina project (commencement by December 2012) will contribute thereafter.

While there are some concerns in the near term, most of these are priced in say analysts, who believe there is reasonable upside from current levels of Rs 130, given the one-year consensus target price of Rs 160.