Hindalco - Margin pressure seen, TP cut, maintain Buy - Centrum

Hindalco's operational performance was disappointing both on standalone and at Novelis levels but we see only marginal downward revision to our earnings estimates because expansion led volumes and sharp depreciation in rupee will mitigate cost pressures going forward and support earnings. We see the commissioning of Utkal and Hirakud FRP projects as a key positive that will drive volume growth leading to higher share of VAP in aluminium business. Novelis is also expected to see ~3% volume growth in FY14E on account of timely commissioning of expansions in Brazil and Korea. We cut our target price to Rs108 from Rs122 earlier on account of downward revision in earnings due to cost and realization pressures. Maintain Buy.

Volume surprises positively in standalone aluminium but Novelis disappoints : Aluminium production stood at 139kt, up 5.3% YoY and alumina production went up by 4% YoY to 348kt and this surprised us positively. VAP volumes were subdued due to the lockout at Silvassa foil plant and stood at 59kt. Novelis' adjusted EBITDA for Q1 dropped by 21%YoY to US$204mn. This was a disappointment due to softer can demand in North America and higher metal premiums in Asia. We have cut our EBITDA estimates for Novelis by ~4% for FY14E.

Margin pressure on higher costs and subdued metal prices: EBIT for aluminium division was lower by 12% QoQ and ~8% YoY to Rs2.5bn despite higher volumes due to lower realizations and higher overall costs. EBIT for copper division was higher by ~7% YoY to ~Rs0.8bn. Standalone margin dropped to 8.2% (down 100bps QoQ).

Sharp rupee depreciation and expansion led volumes to mitigate impact on overall profitability: We see sharp rupee depreciation providing the key mitigating effect for earnings hit by lower metal prices and subdued demand. Hence we do not see substantial downward revision to our earnings estimates despite sharp reduction in LME price assumptions (cut by 9.5%/11.9% to US$1900/1938 for FY14E/15E) as INR/USD estimates are rebased to 58/57 for FY14E/15E. Hindalco announced first metal tapping at Mahan and the commissioning of Utkal refinery during Q1. Expansion at Novelis is on schedule with 110kt incremental volumes targeted from new capacities in FY14. We maintain volume estimates and marginally revise EBITDA estimates downwards for the consolidated business.

Valuations and risks, maintain Buy: We remain positive on the commissioning of Mahan and Utkal projects in H1FY14 which is expected to ease cash flows, release long standing CWIP and deleverage the stretched balance sheet. We value the company on SOTP basis using EV/EBITDA methodology on FY15E earnings and arrive at a fair value of Rs108. Maintain Buy. Key downside risks are cost escalations at new projects, lower than expected volume ramp up and continued earnings pressure at Novelis.

Source : Equity Bulls

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