NOVELIS’ RECORD PROFIT EASES MOST CONCERNS

Parent entity Hindalco seen to continue benefiting as analysts see further improvement in Novelis’ margins

Novelis, the US subsidiary of Hindalco, continues to clock good numbers. It has reported its highest-ever earnings before interest, tax, depreciation and amortisation (Ebitda), excluding exceptional items, for the March 2018 quarter (fourth or Q4 of 2017-18).

This was the third consecutive quarter of record operating profit, enabling Novelis to surpass its FY18 Ebitda forecast of $1.15-1.2 bn. The strong show should put to rest concerns about volatility in aluminium prices impacting the conversion ratios. Novelis is a convertor of aluminium metal into value added products.

Analysts say improving cash flow will help lower its debt, despite the expansions and additional capital spending planned. Edelweiss Securities remains upbeat on sustenance of the earnings momentum and believes contracts with customers will facilitate passing of costs, despite current price volatility. A deleveraged balance sheet, with the ratio of net debt to Ebitda at 2.9, will enable growth-oriented capital expenditure in the automobile segment, they add.

Helped by growing volumes, an improved product mix, with rising share of automotive products and favourable scrap pricing, partly offset by lower beverage can pricing, Novelis’ Ebitda was $319 million, an increase of nine per cent over a year and five per cent from the earlier quarter. High-margin automotive shipment increased 11 per cent over a year, comprising a fifth of the product mix in FY18.

A nearly 15 per cent increase in realisation due to higher aluminium prices and a two per cent year-on-year rise in shipment to 805,000 tonnes helped Novelis report net sales of $3.1 billion, an increase of 17 per cent, year-on-year. Cost efficiencies boosted the performance. Per-tonne Ebitda increased by seven per cent over a year and three per cent sequentially to $396 in the March quarter. For FY18, the adjusted Ebitda at $1.21 billion was up 12 per cent year-on-year and Ebitda per tonne was $381.

The trend is expected to continue. Analysts at JM Financial say the new pricing contracts in the June quarter for beverage cans and automotive products will allow the company to pass on the increased metal cost to customers. Scrap spreads (difference between scrap and metal prices) in dollar terms also remain strong.

Analysts at Motilal Oswal Securities believe the Ebitda will increase further to $1.3 billion in FY20, led by continued improvement in product mix, higher volumes and the end of margin pressure in beverage cans.

The improving performance resulted in a 12 per cent year-on-year increase in free cash flow during FY18 to $406 mn (excluding $314 mn from sale of stake in its Korean rolling mill to Kobe Steel) and helped Novelis cut net debt by $672 mn. As a result, the net debt now stands at 3 times its Ebitda, from 3.9 times earlier.

Expansion

The company is also expanding production in the US by setting up a 200,000 tonne automotive finishing unit in Guthrie, Kentucky. Leveraging on its early mover advantage in the segment, Novelis is targeting automotive opportunities in both the west and the east. It has doubled its capex to $450 mn for FY19, to capitalise on growth opportunities in the auto space in the US and China. It also agreed to acquire operating facilities and manufacturing assets in Sierre, Switzerland, which have historically been leased, and will incur another $245 mn for buying out the finishing line. Other inorganic options, too are open.

However, Novelis has told analysts it will not exceed a net debt to Ebitda ratio of four in an acquisition and return to one of three in 18-24 months, in the event of a buyout. This indicates acquisitions are unlikely to be adventurous.

Outlook

With operating performance improving, concerns on the impact of US tariffs and volatility in aluminium prices have also been put to rest. The strong Novelis show should also aid Hindalco’s consolidated performance, already benefitting from integrated domestic smelter capacities. Improving cash flow should continue driving debt lower.

Given the outlook, analysts are positive on Hindalco, with target prices for the stock at ~305-370 after Novelis’ results, a 27-55 per cent upside from the current ~238.85.