Hindalco an underperformer; targer of Rs 124: Karvy

Karvy Stock Broking firm has recommended an underperformer rating on Hindalco Industries. Research firm expects the stock price will fall to Rs 124. Novelis Inc., which was acquired by Hindalco Industries in May 2007, has reported the Q1FY08 financial results. The results continue to suffer due to the price ceiling contract losses of around US Dollar 80 million for the quarter. These losses are likely to continue till FY2011. Hence, Hindalco's management has already stated that the acquisition would be accretive to Hindalco only by FY2011. Net sales grew by 10.3% YoY to US Dollar 2,828 million. Sales volume for the quarter was almost flat at 755,000 tonnes compared with 753,000 tonnes YoY. After adjusting for one time items, the loss before tax was US Dollar 18 million as against a loss of US Dollar 87 million. Though the reduction in loss looks impressive, we have concerns over the low EBIDTA margin of less than 5%. Even if we make adjustments for the price ceiling contracts, it would be difficult for the company to report EBIDTA margin of 10% plus. Novelis has the capacity to produce 3.5 million tonnes of aluminium value added products. According to the management, the replacement cost of the capacity is USD 15 billion. This makes the Hindalco's acquisition cost of USD 6 billion appear very attractive deal. We have tried to analyse the payback period of the acquisition to see if it has been a good acquisition. Our analysis reveals that based on the Q1FY08's annualised adjusted EBIDTA, Hindalco's payback period for the acquisition works out to be 12 years. In order to shorten the payback period, the current adjusted USD 164 per tonne has to increase substantially. This might happen once the price ceiling contracts expire by FY2011. Apart from the loss incurred by Novelis, Hindalco's consolidated results are also going to be hit by the interest cost on USD 3.1 billion debt in the books of SPV, which was created for the purpose of acquisition. Moreover, Hindalco's stand alone performance in FY08 is also unlikely to be significantly better than that in FY07 as the LME aluminium price has not been strong and appreciating rupee has been making the matters worse. The company can not offset the lower price realization with a robust sales volume growth due to the capacity constraint in FY08. We maintain our Underperformer rating on the stock with target price of Rs 124.