After a stellar FY17, more gains ahead for Hindalco
Firm prices, stable costs with debt reduction to drive earnings growth
Hindalco’s share price has grown 2.2x in the past one year (FY17) as business prospects improved substantially. And, there are more gains in the offing. With base metal prices rebounding from lows, completion of capacity expansions and improving profitability of domestic operations as well as Novelis (its US subsidiary) cash flow will increase further and help cut debt. While debt is seen declining, interest costs could fall faster.
Following successful bond refinancing during the September quarter, Novelis refinanced its $1.8 billion term loan with Asian banks in January 2017, which will lower its interest costs. Novelis has already revised its free cash flow guidance to $350 million from $300 earlier. Hindalco also plans to repay $1 billion debt, using part of its existing cash as well as from the ~3,350 crore of equity funds it raised last month from institutional investors. Thus, analysts at CLSA see FY18end net debt-to-equity declining from 1.2x to 1.0x. All this will also help the company improve its credit ratings, and allow it to refinance the costlier loans at lower rates. CLSA sees an 18 per cent decline in interest costs for Hindalco in FY18.
The next round of downstream capacity expansions will further boost profitability. After completing its major capacity expansions, Hindalco is enhancing its focus on value-added products, which will boost operating profit margins. Over the next 12-18 months, the start of the company’s third copper rod plant at Dahej in Gujarat will raise capacity to 90 per cent of cathode capacity (currently 50 per cent) and, de-bottlenecking of alumina capacity at Utkal from 1.5 million tonnes per annum (mtpa) to 2.1 mtpa will boost the company’s Ebitda.
CLSA estimates that against total capex of ~3,900 crore, the total incremental Ebitda will be ~1,100-1,200 crore annually, making these high-ROCE projects (return on capital employed 25 per cent). Analysts also say that the implementation of the goods and services tax (GST) will help reduce logistic costs, as will the new rail links and eastern corridor rail links.
Meanwhile, the cost of production is rising internationally on higher raw material prices. Hindalco, however, has some advantage due to captive supplies, and its costs are significantly insulated. In fact, analysts at Jefferies believe Hindalco should benefit from rising cost at Chinese smelters, as it sets a higher floor on prices, while Hindalco’s costs are resilient.
With all these benefits, analysts at Jefferies say that equity offering overhang is behind us and deleveraging should continue as they estimate net debt to fall to ~44,600 crore (~54,900 crore at end of December 2016 quarter) and net gearing to decline to 0.9x in FY18. In this backdrop, analysts have raised their target price for the stock now trading at ~194 levels. CLSA has raised its target price from ~210 to ~230, while Jefferies has raised it to ~226.