Underperform rating on Hindalco shares: Daiwa

Updated: Dec 16 2013, 19:33pm hrs
Whats new: We recently met the management of Hindalco Industries Ltd and are reviewing our outlook for the stock after its 20% rise over the past six months. While we are optimistic about subsidiary Noveliss performance in H2FY14 and FY15, we remain cautious on Hindalcos India aluminium operation, as we have turned more bearish on LME aluminium prices.

Whats the impact

Outlook for aluminium prices: We have turned more bearish on aluminium prices driven by weak fundamentals, as we forecast the global surplus to rise from 1.6m tonnes in 2012 to 3.0m tonnes in 2015. We are cutting our aluminium-price forecasts by 8% for FY14 and by 9.3% for FY15.

Earnings-forecast revisions: We are cutting our PAT forecasts by 14% for FY14 and 20% for FY15, driven by lower LME aluminium prices and the effect of the increase in our interest and depreciation-cost assumptions.

Cautious on India aluminium business: We have turned more cautious on the companys India business, as we now do not expect the Mahan coal block benefit to be felt until Q4FY15. We do not expect the Mahan smelter to be PAT profitable unless Hindalco starts operating the Mahan block.

What we recommend

We are lowering our FY15 SOTP(sum of the parts)-based six-month target price to R114 (from R135), driven mainly by the downward revisions to our earnings forecasts. Accordingly, we are downgrading our rating to Underperform (4) from Buy (1). Rationale. We have become more bearish on LME aluminium prices, and we consider the EV/Ebitda (enterprise value/ earnings before interest, taxes, depreciation, and amortisation) valuation to be unattractive following the strong 20% share-price rise over the past six months. In addition, we expect the start-up of the Mahan block to be delayed, while we expect higher interest and depreciation costs due to the capitalisation of its Utkal and Mahan facilities to have a negative impact on PAT in coming quarters. The key risks to our call would be higher-than-expected LME aluminium prices and the early start of the Mahan coal block.

Ebitda and PAT growth

We forecast a consolidated Ebitda CAGR of 11.9% for Hindalco over FY13-15, driven largely by our 14.6% aluminum sales-volume CAGR (compound annual growth rate) forecast for its standalone business and 7% CAGR for rolled aluminum shipments at its US subsidiary, Novelis. However, on the contrary, we forecast a flat 1% PAT CAGR over the same period, driven mainly by the negative impact of higher interest and depreciation costs, due to the capitalisation of the Utkal refinery and Mahan smelter (total investment of R185 bn in these two projects, R160 bn already spent as of September 2013).

Daiwa Capital Markets