Inventory concerns overdone; destocking accounts for 32% of LME stocks
The financial crisis resulted in possibly the most massive destocking ever witnessed
by the aluminium industry. The supply chain players (producers,
distributors/traders) moved their core inventories to LME warehouses to raise cash
and battle the crisis; we estimate over 32% of LME inventories to be such core
inventories. Hence, we believe the market is much less oversupplied than what the
consensus has factored in. As global recovery gains momentum in CY10, we expect
the supply chain to draw down exchange inventories and stock up to their original
levels.
􀂄 Real aluminium prices still at historically low levels
In spite of rising ~40% from the bottom, aluminium prices are at historically low
levels in real terms. Even at the current inventory levels, a price level of USD
2,300/tonne is sustainable, which is our revised assumption for FY11E.
􀂄 Global demand recovering rapidly; up 20% from bottom
Key end-user sectors of aluminium viz. auto, construction and packaging have
grown globally at 2.5-4.0% M-o-M for the past four months. We estimate long-term
aluminium demand growth rate at a conservative 4.5% p.a. (considering effects of
the crisis; pre crisis, global aluminium demand growth was at 7.5% p.a.). We
expect CY10 global demand to grow 13% Y-o-Y, and yet remain ~9% below longterm
potential.
􀂄 Restarts triggered, but are in response to demand increases
We believe restarts are happening after producers have seen sustainable demand
increase. Further, we note that in spite of Chinese restarts in the past three months,
China continues to be a net importer; and Chinese exports have declined ~16%
from July 2009 levels, indicating no excessive supplies.
􀂄 Outlook: Upgrading aluminium prices by 31% and Hindalco to BUY/SO
We are revising our FY11 aluminium price estimate from USD 1,750/tonne to USD
2,300/tonne. We are also upgrading Hindalco from REDUCE/SU to BUY/SO with a
fair valuation of INR 169/share, a 40% upside over CMP. Novelis’ margins are
improving; developed world demand is picking up and derivative losses are
expected to ease December 2009 onwards; Hindalco’s standalone aluminium
business is best placed amongst its domestic peers with high level of backward
integration and value-added product mix. We upgrade NALCO from REDUCE/SU to
HOLD/SP with a fair valuation of INR 377/share, a 13% upside over CMP. We like
NALCO’s long position in alumina and its strong balance sheet. We retain our
BUY/SO recommendation on Sterlite Industries (Sterlite) with a revised valuation
of INR 849/share. We believe Sterlite has emerged as the default play on base
metals in the Indian context along with an emerging commercial energy business
with a starting capacity of 2,400 MW.