HINDALCO rides the commodities tailwind, and more
HINDALCO is attractive not merely due to macro tailwinds but a favourable business mix. With a strong balance sheet and high CF generation, this giant is well positioned for its next leg of growth.
Started in 1958, HINDALCO (Hindalco Industries Ltd) is Aditya Birla Group’s metals flagship company. A US$18 billion topline powerhouse, HINDALCO is an industry leader within the aluminium and copper value chain.
As the world’s largest fully integrated aluminium company by revenue - starting from alumina all the way to downstream products - HINDALCO’s wholly owned subsidiary Novelis is the world’s largest aluminium FRP (flat rolled products) producer and aluminium recycler. Utkal Alumina - one of HINDALCO’s refineries - is amongst the world’s lowest cost producers of alumina.
HINDALCO’s copper division (~1/5th contribution to total sales) operates one of the world's largest custom smelters at a single location, focusing mainly on downstream products.
The company has a footprint in 10 countries and employs over 40,000 persons worldwide.
Supportive tailwinds at play
Global aluminium market is sized at $164 bn in 2019 and projected to reach $242 bn by 2027, growing at a CAGR of 5.7%.
Each ton of aluminium consumes around 14 MWH of power which in turn emits large huge amounts of carbon. The recent surge in energy prices across the world and China’s power rationing regime have resulted in supply side disruptions. Moreover, considering environmental concerns around manufacturing aluminium, future expansion in China has been capped. This supply shortage along with pent up demand for aluminium automotive sheets, beverage cans, and requirements of the Aerospace industry post pandemic are expected to increase consumption in a structural manner.
Global automotive aluminium FRP demand is expected to rise by 11% CAGR between CY 2021-2028 owing to rising push towards Electric Vehicles (EVs). This is supported by the fact that by 2026, aluminium content in a vehicle is expected to rise by an average of 42kg per vehicle. Moreover global demand for beverage can stock is projected to increase by 4% annually till 2028, driven mainly by growth in beverage markets and substitution against glass and plastic.
Broadening competitive advantage over next 5 years
After deleveraging in an accelerated fashion, HINDALCO has decided to now focus on business expansion and has allocated ~$8bn to expand its aluminium business over the next 5 years of which $3.37 bn is to be invested in Indian operations and remainder $4.5-4.8 bn to go to US, Brazil, Germany, and rest of Asia via Novelis. From a value chain standpoint, capex is allocated to in part towards upstream and also towards downstream to support HINDALCO’s valuation going forward e.g. investment in captive coal mines would help the company get benefit of an integrated supply and at the same time its investment in Value Added Products (VAP) segment would help achieve more stable margins. Novelis is expected to have a rolling and recycling capacity of 5.8 MT by 2027 v/s current capacity 3.8 MT. HINDALCO’s focus on increasing its recycled aluminium capacity could benefit from the fact that aluminium is expected to be recycled more going forward due to recycled aluminium’s cost benefits vs. other materials.
HINDALCO derives around 80% of its revenue from aluminium and the rest from copper. Of the 80% aluminium revenue, almost 65% originates from Novelis.
Novelis holds a 40% global market share (excl. China) in the beverage can sheet segment. Over the years various acquisitions such as Aleris helped the company gain market share on a macro level.
Potential risk factors
High prices of commodities such as aluminium and copper provided abnormal margin expansion to the company. However, prices appear to have peaked. Though it is expected that demand would remain at elevated levels owing to a need for infra development in a post Covid era, the potential scenario of the Ukraine-Russia conflict resolving along with the restart of idle capacity in China, could push prices down. The price of coal (an important input) has also surged recently due to higher than expected monsoons in Australia. Similar environmental or geopolitical factors could add volatility to the mix.
Improving financials and strengthening balance sheet de-risks the profile
Revenue has seen a CAGR of 5.46% during FY 2016-21 helping the company deliver a 9.5% ROCE on an average for the last 5 years. EBITDA margin increased by c. 4.41% due to the changing product mix towards downstream along with cost optimization. Average realisation has grown almost by 2x due to movement in prices. Operating leverage is favourable with EBITDA growing 3x the revenue growth on a y-o-y basis during 9MFY22. Financial leverage looks fairly accommodative with net debt-to-EBITDA of 1.62x and interest coverage ratio of 7x (LTM) as of Q3FY22, up from 5x as at FY21. Cash Flow generation is strong with robust operating CFs of INR17,232cr (13% of revenue) in FY21. A capex plan of $8bn over the next 5 years implies annual capex of roughly INR12,000cr - relatively accommodative given the deleveraged balance sheet and strong cash flows. Revenue for Q3FY22 stood at INR50,272cr, increasing by 5% on q-o-q basis and 44% on y-o-y.
Valuation on absolute and relative terms look attractive
HINDALCO currently trades at 9.6x P/E and 0.8x EV/Sales on LTM basis. Close domestic comp National Aluminium Co Ltd (NSE: NALCO) trades at 6.87x P/E and 1.37x EV/Sales while Foriegn listed comps Alcoa Corporation (NYSE: AA) trades at 30x P/E and 1.07x EV/Sales; Norsk Hydro (OSL: NHY) trades at 13.54x and 1.14x EV/Sales. In July 2021 the company received a ratings upgrade from CRISIL from AA/Positive to CRISIL AA+/Stable. Promoters own 34.64% of outstanding shares with DIIs owning 19% and FPIs holding 29%.
HINDALCO is ideally positioned to capitalise from increasing aluminium & copper demand in the near-to-medium term. Dependency on macro tailwinds would be a potential risk factor to be considered. We are LONG.
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Disclaimer: The views expressed above are the views of Arkvega Partners LLP, and are subject to change at any time based on market and other conditions. This is neither an offer nor solicitation for the purchase or sale of any security, and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. We strongly advise you to do your own research and consult an accredited investment advisor before investing based on what you read in a newsletter. Arkvega Partners LLP or its employees may have exposure in the financial instrument discussed above and can close positions in the future without prior intimation.