Advantage Novelis from rising spread between recycled prices of the metal and trading quotes at LME

The Aditya Birla Group, which owns global aluminium producer Novelis, is set to benefit from the rising spread between recycled prices of the metal and its trading quotes on the London Metal Exchange (LME), with the ease in scrap collections making European and North American plants more globally competitive for recycled output.

Novelis, the US-based subsidiary of Hindalco, makes automotive sheets and beverage cans and has facilities in Europe, North and South America, and Asia. Last fiscal, the aluminium convertor used about 60% scrap, the usage of which is relatively higher in the developed markets such as the US compared to Asia.

Thus, the rising recycling spread over the LME prices will give Novelis an advantage over its competitors, mainly mainland Chinese companies. On scrap usage, Novelis earns a spread between the price of recycled aluminium and LME aluminium prices, and the local premium. The spreads have increased to almost $900 per tonne from $700 per tonne in the beginning of CY2018.

This will boost Novelis’ EBIDTA per tonne, which analysts expect to be in the range of $900 to $1,000 per tonne. Data over the past seven years (2011 to 2018) show a high correlation between Novelis’ EBIDTA per tonne and the pricing spreads.

Other than US, Novelis also has operations in Brazil where it is expected to benefit from the weak Brazilian currency, which has fallen 12% against US dollar in the last three months. While Novelis Brazil’s revenue and raw material costs are dollar denominated, conversion costs are determined in the local currency.

Novelis contributed almost 60% of Hindalco’s consolidated operating profit (EBIDTA) in FY18. The outlook for Hindalco’s Indian operations of aluminium remains positive. Lower aluminium inventory (Ex-China) is also positive for Hindalco: From January to May 2018, world markets were in aluminium deficit of 1.1 million tonne. The rupee depreciation over the last few months will also help Indian operations. Hindalco’s shares are down 13% in the past two months and are trading at FY20 expected EV by EBIDTA of 5 times as compared to historical average of 6.5 times. This is at a 15% discount to its global peers as compared to historical average of 10% premium. With improving fundamentals, these valuations appear attractive. However, investors will be looking at global trade policies that could impact Hindalco’s operations. Investors will also be watching out for any acquisitions by Novelis, given that it operates at close to full utilisation and has about Rs. 48,000 crore in long-term debt on its books. In case of any inorganic growth, the valuation of any likely acquisition will influence its share price.