Impact On Hindalco If Novelis Buys Aleris

Novelis, the U.S.-based downstream arm of India’s largest aluminium producer Hindalco Industries Ltd., will meet today to consider the buyout of Aleris International Inc, newspaper Business Standard reported.

The company could value the U.S.-based rolled aluminium products maker at $2.5 billion, newspaper Business Standard reported today. Bloomberg first reported on a possible deal in January.

Hindalco, in an exchange notification, denied that any such proposal is being considered by the board at this point. Shares of the company ended 1 percent lower compared to a 0.4 percent decline in the metal index on Friday.

But what will Hindalco, or Novelis, gain if it goes ahead with the deal?

Capacity Addition In No Time

Aleris recently commissioned its $425-million automotive body sheet unit in Kentucky and has already started shipping products from there. The expansion comes when U.S. President Donald Trump has imposed tariffs on aluminium imports.

An acquisition would add 1 million tonnes to Novelis’ 3.6-million-tonne downstream capacity where organic growth usually needs about five years of gestation, brokerage firm Macquarie said in a note.

According to JP Morgan, the ABS project in particular would allow Novelis to add capacity quickly and save 3 years that a greenfield project would take.

Geographic Benefit

A potential deal would help Novelis increase its presence the North America and Europe—the two biggest contributors to Aleris’ revenue.

Product Mix

Aleris would increase the company’s share in high-yielding automotive segment. And it also fits with Novelis’ strategy of increasing its exposure to the auto sector.

Novelis derives most of its revenues from the beverage can segment, followed by auto body sheets. It’s gradually moving away from specialty steel, according to a report by Goldman Sachs.

How Valuations Stack Up

Hindalco’s shares fell to a 12-month low amid concerns over the company overpaying for a potential downstream acquisition.

The company, according to reports, may do the deal at an enterprise value of $2.5 billion. That implies EV/Ebitda ratio of 7.7 times compared with the industry average of 6 times—according to estimates tracked by Bloomberg. This is based on projected earnings before interest, tax, depreciation and ammortisation for 2019.

Aleris’ $201 million adjusted Ebitda for 2017 included $38 million impact of outages at both its aerospace and auto facilities. The company, in its annual presentation, said aerospace and automotive could have a positive impact on $30 million and $75 million on its Ebitda, respectively, in 2019. That could increase underlying Ebitda to $344 million. And this doesn’t include any synergy benefits that the company would start incurring.

So, the deal valuation at 7.1-7.6 times of EV/Ebitda estimates for 2019 is similar to listed peers without factoring in strategic benefits and growth potential, Macquire said.

Impact On Hindalco’s Leverage

While the transaction could likely be done by Novelis, it’s the impact on Hindalco’s books that’s worth examining for Indian investors.

Hindalco’s debt to Ebitda stands at 2.8 times—given its consolidated net debt of Rs 43,227 crore and Ebitda of Rs 15,025 crore as of March. If it indeed buys out Aleris for $2.5 billon (about Rs 15,792 crore), net debt will increase to Rs 59,020 crore for an Ebitda of 17,976 crore—including estimate of Rs 15,891 crore debt and Rs 2,084.6 crore Ebitda for 2019-20. That will take the net debt to Ebitda to 3.3 times, in line with industry average of 3—based on analyst estimates tracked by Bloomberg.