Hindalco’s bid to acquire Aleris Corp (as per unauthenticated media reports) indicates its preference to invest in the downstream value-added rolled product business given poor returns in the upstream aluminum smelting operations. The demand drivers for rolled products remain solid — (i) automotive sheet demand in North America will likely result in a supply deficit, and (ii) there is large order backlog in aerospace industry. Aleris is positioned well to capture these opportunities with large new investments which are yet to reflect in earnings. Choice of upstream versus downstream investment?
The capital allocation for an aluminum producer is a choice between (i) upstream aluminum smelting operations, versus (ii) downstream value added products. We highlight that investment returns in the first case (smelting) have remained low due to China overcapacity— we estimate post tax RoIC of close 2-3% at the spot aluminum prices & capital costs; such has been the case for the last four to five years. This may improve from China supply side reforms though reforms are yet to bear fruit meaningfully. We also highlight that acquiring captive raw-material presents another challenge in India. The downstream rolling operations offer superior returns on two counts (i) higher earning potential based on the spot economics given impact of China overcapacity in rolling industry is limited to Asian region, and (ii) growth opportunity from emerging end-user sectors such as automotive rolled products.
Aleris — a growth story Media reports (quoting sources) indicate Hindalco has bid for Aleris Corp. through a non-binding offer by its subsidiary Novelis at a valuation close to $2.5 bn. Aleris is a leading manufacturer of rolled products (similar to Novelis) though its product profile differs from Novelis’— it includes aerospace (14%), building & construction (24%), truck trailer (8%), distribution (22%) beside automotive products (14%). A promising story at a price As of September 2017, Aleris had a net debt of $1.64 bn and earned Ebitda of $206 mn (12 month trailing). The valuations at 12X trailing Ebitda (at $2.5 bn per media) do not fully capture the earnings potential of Aleris.
They do not reflect earnings from (i) a 220 ktpa auto body sheet (ABS) capacity in Lewisport, USA entailing capex of $425 mn commissioned in November 2017, (ii) a $350 mn investment in China for aerospace applications; about 70% of expected Ebitda run-rate is not yet reflected, and (iii) a further 33% in Ebitda improvement expected in ABS facility in Germany
($85 million investment).