Aluminium LME has been range bound, but proposed Al supply cuts in China, if executed, may tighten Aluminium (Al) markets. We believe markets would focus on execution of (i) non compliant capacity cuts (Oct) and (ii) winter cuts (Nov), in our view. Higher cost at Chinese smelters should underpin Al prices, if execution disappoints. We believe Novelis should be unaffected by US probe on Al imports, while margins should improve on rising autos mix. Deleveraging story stays intact. Buy
Al LME range bound, but capacity cuts news flow has picked up: Chinese Al output has been stable, but uptick in Al exports (7% MoM) and lower alumina prices (lower cost support) likely contributed to the softness in prices early June. However, news flow around capacity cuts have picked up in recent weeks, as deadlines around Chinese supply reform plans approach. Costs at Chinese smelters have also increased ~$90/ton from recent lows.
Execution of supply reforms could be positive trigger: The Chinese government is clamping down on non compliant Al smelters. Smelters that stay non compliant in Oct may potentially be shut. Separately, the Chinese govt’s plan to suspend 30% of Al capacities in 4 provinces during winters, may hit Chinese Al output by 1.2-1.4 mn tons. Execution of these measures could be positive for Al prices. There may be some disappointment, if supply cuts are not implemented, but higher costs at Chinese smelters should limit downside risk to prices.
Linkage coal wins may lower Al costs: HNDL sources 35% of its coal needs (c.5.5 mn tons) through e-auction. Potential coal linkage wins at a discount to e-auction prices during coal linkage auctions may lower Al COP.
Novelis — Section 232 probe on Al imports not a major concern: The US government has launched a probe on Al imports on national security concerns. Novelis imports part of its Al inputs (est. ~30-40%) through imports (mainly Canada) and is thus exposed to potential broader tariff on Al imports by US. However, we think Novelis should be unaffected as (i) US Al industry has stated that trade measures should focus only on China and (ii) we think imports from Canada would be exempt, even if US imposes any tariff measures. We expect Novelis Ebitda to rise to $352/ton in FY18 from $344/ton in FY17.
Valuation/Risks: HNDL is trading at 6.2x FY18e Ebitda (avg 7x FY1 ex post.) Our SOTP-based PT is Rs 237. We value India operations at 6x FY18E Ebitda and Novelis at 7x FY18E Ebitda. Risks: lower Al prices; higher coal costs; lower margins at Novelis.