Completion of capacity expansion at Hindalco (India) and Novelis’ (the US) units in FY16 and F17, falling raw material costs (especially coal), and commodity prices underpin an expected sharp uptick in FY17E earnings and the 87% share price rise in FY16.
But, further positive surprises are unlikely; the step-up in earnings has happened and the market has given credit for improved balance sheet prospects, in our view. For investors bullish on medium/long-term commodity prices, we believe there are other more directly exposed companies. Note that UBS has a structurally bearish view on aluminium and copper smelting. With downside risk building, we initiate coverage of Hindalco Industries with a sell rating.
A volume step-up at Hindalco (45% FY17E consolidated EBITDA) occurred following the capacity ramp-up. We expect further benefits from falling fuel costs in FY17 as well as potential efficiency gains. But, we believe these are factored into FY17 consensus estimates and are marginal beyond this. Aluminium prices and copper treatment/refining charges could drive earnings upside, but the UBS Commodities team is structurally cautious in both cases. Similarly, at Novelis (55% FY17E consolidated EBITDA), there should be further volume and mix benefits from completed new finishing capacity, but mix pressures imply profitability will be range-bound, especially as Novelis focuses on cash flow and deleveraging.