Company Analysis

Hindalco is currently trading on BSE and NSE at the following prices.

The fundamental analysis and valuation of the company has been carried out by using two approaches.

1. Discounted Dividend Model

𝑃 = 𝐷1 ÷ (𝑘 − 𝑔)

1. Estimating the value of Sustainable growth Rate(g)

Dividend Paid
The dividends paid by Hindalco is shown in the adjoining
1.5 figure. Since the growth is fairly constant for the last 5 years
1 and follows a trend we compute the CAGR of dividends for the
5 years which comes out to be 4.66%.
0.5
2014 2015 2016 2017 2018

The value of g can also be approximated using the ROE approach.

𝑔 = 𝑅𝑅 ∗ 𝑅𝑂𝐸

RR
The retention ratio for the last 5 years is as shown in the figure.
1
The mean RR comes out to be 73.78% which implies that the
0.5 company still believes it can become more profitable by
investing in itself.
0
2014 2015 2016 2017 2018

ROE(%)
6.0
4.0 The ROE for the last 5 years is as shown in the figure. The
average ROE is around 2.77%, which is typically low as
2.0
compared with other aluminum companies.
0.0
2014 2015 2016 2017 2018
 Hence growth rate by ROE approach = .737* 2.77 % = 2.04%

The growth rate given by ROE approach is 2.04% while that by historical trend is 4.66%. We
take the average f both pf these approaches which gives growth rate of dividend to be equal
to 3.35%.

2. Estimating the required rate of return(k) using CAPM

Sensex on 18 Nov 2014 28209.03

Sensex on 18 Nov 2018 35457.16
Growth rate of Sensex 5.88%
Risk Free Rate 7.00%
Long Term Beta 1.77
Expected Return using CAPM(k) 5.02%

𝑅𝑖 = 𝑅𝐹𝑅 + 𝛽(𝑅𝑚 − 𝑅𝐹𝑅)

Yields of the 10-year government bonds have been used to compute the risk- free rate of return. Hence
the RFR comes out to be 7%.
While for the market rate we have considered the returns on Sensex from 2014 to 2018, which gives a
return of 5.88%.
Long term β of Hindalco is 1.77 (Source: Money Control)

So, the k comes out to be 5.02% using the above-mentioned equation.

3. Computing the Price

The Aluminum supply is going to reduce in the near future because of cuts from the Chinese companies
and moreover strong domestic demand which has picked up once again after the effects of GST and
Demonetization have been shrugged off is likely to provide a boost to the company’s growth. Hence the
growth is likely to pick up from 3.35%. The dividend paid in 2018 was 1.2Rs/share.

We have assumed the growth to increase from 3.35% to 4% in the second year, to 4.5% in the third year
and a constant growth rate of 4.5% thereafter.

Hence the price comes out to be Rs. 245.96 using the DDM.

2. Operating Free Cash Flow Model

𝑃 = 𝐹𝐶𝐹𝐹1 ÷ (𝑊𝐴𝐶𝐶 − 𝑔𝐹𝐶𝐹𝐹 )

1. Computing the growth rate of FCFF (𝑔𝐹𝐶𝐹𝐹 )

The firm Operating Free Cash Flows generated by the company have been pretty erratic as shown in
the figure.
 Hence the growth rate of FCFF has been computed using the ROIC and RR.

𝑔 = 𝑅𝑅 ∗ 𝑅𝑂𝐼𝐶
The retention ratio is 73.7% as mentioned earlier.

ROIC average from 2014 to 2018 comes out to be 9.07%

Hence, the growth rate of FCFF, g = 0.737 * 9.07% = 6.69% (Approximated to 6.5%).

2. Weighted Average Cost of Capital (WACC)

𝑊𝐴𝐶𝐶 = 𝑊𝑒 𝑘 + 𝑊𝑑 𝑖

The debt to equity ratio for is Hindalco is 0.41. Hence 𝑊𝑒 =0.71 and 𝑊𝑑 =0.29.
k=5.02%
Debt is assumed to be lend at a rate of 10% with a tax rate of 25%. Hence i = 7.5%
WACC = 5.74%

3. Since g > WACC, the FCFF model cannot be applied. We have assumed that the growth rate will remain
6.5% till 3 years (high growth rate period) will progressively reduce to 6%,5.5%,5%,4.5% in the 4th,5th,6th
and 7th year (declining growth) respectively and then become constant at 4.5%.

The total value of FCFF after discounting using WACC comes out to be 83,722.4 Cr INR.

Reducing the outstanding debt and dividing by the outstanding shares, Stock price: Rs 296.80

Stock price on 18/11/18: Rs 230

Price according to DDM: Rs 245.96
Price according to FCFF: Rs 296.54
Both the methods of valuation using company analysis, show that the stock is undervalued, and hence
one should invest in Hindalco from a long-term perspective.