Novelis, Hindalco’s subsidiary, has declared 3Q FY3/09 results, which met our expectations on operational level but were impacted by $1.3 billion goodwill write down after an annual impairment test.
Novelis has been able to maintain its operating profit at $69 million in spite of an 18% drop in volume by cutting S&G costs. The margins actually improved q-o-q, from $85/t to $105/t.
Novelis achieved sales of 659kt, down 13% y-o-y Can sheet sales though considered more stable were also down 5% due to destocking by the can manufacturers. Can sheet contributes 48% of sales and will recover and should drive the sales a bit higher. Our assumption for 4Q remains conservative at 637kt.
The hedging losses were $405 million; however, the permanent loss is limited to $151 million. Novelis has fixed price sales contracts which run as long as 36 months. To hedge the aluminium exposure, it goes long on aluminium on the forward curve.
The sudden fall in aluminium prices have resulted in large mark to market losses, but the losses should be reversed as sales are concluded. Permanent losses would result only for the legacy contracts with fixed metal price ceilings.
Out of the total goodwill of $1.9 billion, the company has written down $1.3 billion, which is per the company’s usual annual goodwill impairment test. Since we always consider book values ex goodwill, it does not change our outlook on valuations.
We have updated the numbers for the write-downs and better than expected Hindalco standalone results. Our EPS estimate is now -46.3 from a profit of 1.8 for FY3/09E; FY3/10E EPS is Rs0.1 from a loss of Rs3.5 and FY3/11E EPS is Rs4.4 from the previous Rs4.
We believe that aluminium prices have bottomed, but are unlikely to move up due to a large inventory overhang. Under this scenario, Hindalco with high debt is unlikely to keep pace with its capex plans and should have slower growth.
Though at 0.5x P/B, it has little downside. We reduce our target price marginally to Rs45 from the previous Rs51.