Aluminum tailwinds, Novelis outlook aid Hindalco’s prospects

Aluminum prices on the London Metal Exchange (LME) have risen 46% to $2,900 a tonne since January. Shortages in bauxite and the risk of short supply from China had pushed prices to several-year highs. China has announced production cuts to meet the decarbonization target. Analysts said, “With power shortages and higher costs (40% of total costs) for Chinese aluminum producers, capacity suspensions (2 million tonnes or 5% of national capacity suspended and expected to come) are due to our bullish take on LME aluminum. Supports the outlook,” analysts said. at BofA Securities.

He estimates that for every $50/tonne increase in LME aluminum, Hindalco could see a 1.7% growth in FY23 earnings.

Hindalco’s domestic operations benefit not only from strong aluminum prices but also from its captive bauxite and alumina capabilities. The supply of bauxite, the major raw material for aluminum manufacturing, is already at risk given the political instability in Guinea, which meets 20-25% of the global supply. Hindalco has adequate supply of alumina and is not dependent on imports. In fact, it had recently undertaken a 0.5 million tonnes per annum (MTPA) expansion project at its subsidiary Utkal Alumina. Given the buoyancy in alumina prices and demand, the company may also benefit from outbound sales of additional alumina. Meanwhile, Novelis, the company’s US subsidiary, also provides a cushion from volatile aluminum prices by being a metal converter. Novelis accounts for more than two-thirds of Hindalco’s operating profits.

Novelis benefited from increased demand for beverage cans, auto sheets and packaging, as well as a pick-up in demand from the aerospace segment. Analysts at JM Financial said “whether makers and sheet makers can continue to drive strong demand in North America and Europe and the second half, price interactions are expected to be higher”.

Novelis raised its margin guidance for FY22 to $500 a tonne based on June quarter earnings. It had reported an adjusted EBITDA margin (Ebitda per tonne) of $522 per tonne (60% y-o-y) for the June quarter. This was higher than the earlier guidance of $480-500/tonne. The increase in scrap margin may further accelerate margins.

JM Financial notes that “scrap spreads constitute a significant portion of Novelis margins and higher spreads suggest further gradual margin expansion in Q3FY22 in our view”.

As a result, analysts have revised Hindalco’s earnings estimates upward. Strong operating performance from Novelis, deleveraging and increase in aluminum prices have strengthened Hindalco’s prospects.