Hindalco: Triggers setting in

New facilities and favourable aluminium prices are positives

Hindalco shares hit a 35-month high of Rs 177.10 on Tuesday before closing 6.8 per cent higher at Rs 175 apiece, as research firm CLSA upgraded the stock from 'sell' to 'buy'. This adds to the 56 per cent gains it has seen since March 2014, led by improving business outlook and market sentiment. And, there is more in the offing.

Aluminium prices, estimated to have bottomed out, have risen to $1,890 a tonne on the London Metal Exchange from $1,677 levels in February. Hindalco's presentation indicates three million tonnes per annum (mtpa) of capacity has shut since 2012, while annual consumption is to grow at five-six per cent. Thus, the global aluminium market (especially ex-China) is shifting to a deficit scenario, supporting prices. However, for a strong rebound in Hindalco's profitability, analysts believe prices should improve to $2,000-2,200 plus levels. This, however, may not happen in a hurry.

Nevertheless, there are gains for Hindalco. Its newly-commissioned capacities are adding to volumes (already up 13-23 per cent in FY14) and cash flows. Expectations of environmental clearances for coal blocks have also raised optimism, especially on profitability of the new aluminium facilities such as Mahan.

Even now, CLSA states the cost structure of new smelters is not as bad - it is better by about $125 a tonne - as they had thought. These, along with the playing out of a structural theme for Hindalco's US subsidiary Novelis, have led the research firm to project the stock price to more than double in four years. The increasing use of aluminium vis-à-vis steel in automobiles in the US market is a big positive for Novelis, which is focusing on and expanding its auto-based capacities. Abhijeet Naik and Nitij Mangal at CLSA expect the share of high-margin auto segment in Novelis' volumes to rise from nine per cent in FY14 to 20 per cent in FY17, driving strong growth in Ebitda. Improving margins in standalone and global operations should boost consolidated earnings over the next few years.

These should hopefully also ease the high debt concerns. Rating agency CRISIL had on June 20 downgraded Hindalco's rating by a notch on long-term bank facilities and debt programmes to 'CRISIL AA/Stable' as it believes capacity ramp-up will happen over around 1.5 years and weak aluminium prices will continue impacting realisations.

However, CLSA estimates the company's debt to start falling over FY16-FY19 by an average Rs 5,800 crore annually, aided by a sharp drop in capex. Hindalco's net debt-equity ratio, thus, is estimated to halve to 0.8 times by FY18. Analysts expect Hindalco's EPS to dip in FY15 due to higher interest and depreciation costs, but thereafter double over FY15-17.