>Hindalco Industries (ICICI Securities)

HINDALCO INDUSTRIES

Worst priced-in

* Novelis remains key concern. With raw material prices (including energy costs) that follow the LME with a lag, declining aluminium prices and falling fixed-price ceiling contract volumes have not released enough cashflows for Novelis. We expect Novelis to post losses till FY11E owing to: i) declining rolled products demand (and premium) across the US and EU and ii) high interest cost burden with annual interest outflow of ~US$180-190mn resulting in depressed acquisition RoIC (3-5%) and prolonged payback (>12 years). Novelis expects ~US$580mn cash outflows relating to settlement of derivatives instruments till FY10E, including US$260mn in Q4FY09. Also, Novelis is exposed to ~US$160mn cash outflows from hedging of exposures to metal price ceiling.

* Weak short-term aluminium price & demand outlook. We had trimmed our CY08/FY09E, CY09E/FY10E & CY10E/FY11E aluminium price assumptions 12%, 15% & 15% respectively on account of: i) reduced Cy09E & CY10E global demand estimates to 0.3% & 2.9% (from 2.5% and 5% respectively), ii) insufficient production cutbacks so far (9-10% of global aluminium production vis-à-vis 25-30% cutback in steel and 15% in zinc), iii) rising inventory, iv) China’s inability to increase demand due to weak internal consumption (with concomitant reduction in CY09E Chinese demand growth estimates to 4.5% from 7.1%).

* Valuations. Backended earnings outlook, increased leverage and the expensive Novelis acquisition dents short-term performance outlook for Hindalco. We expect FY10E EBITDA & EPS to decline 35% YoY each, with RoCE dipping to 3.6% in FY10E (cost of capital: 8.7%). We believe most downside risks are factored-in at current price of Rs39/share (at ~50% discount to replacement cost vis-à-vis 13% for NALCO). Upgrade to HOLD with target of Rs44/share (upside 13%; falls within the medium-risk category of the I-Sec universe).

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