Scrap spreads hit new highs, Novelis margins to follow. The scrap market remains tight due to seasonal collection issues in the West; however, scrap prices continue to underperform strong primary aluminium prices in 4QFY21. UBC scrap spreads at ~US$0.45/lb are now at a two-year high led by higher aluminium LME and physical premiums, not withstanding higher Chinese imports. Peers and customers of Novelis have shared a similar buoyant outlook on both beverage can and auto sheet demand. With strong end-use demand and robust scrap spreads, Novelis margins should remain on an uptrend and drive earnings upgrades. BUY.
UBC scrap prices as a percentage of Midwest P1020 remains range-bound at 59-63% since mid-2020. The market remains tight due to Covid-led collection challenges and seasonal winter headwinds in the West; however, lower imports by China due to policy transition have helped. In 2021 (January-March), strong LME and physical premiums have helped expand scrap spreads, as primary metal prices have outpaced scrap price increase, a regular phenomenon during rising market prices. Scrap spreads in February 2021 are at ~US$0.45/lb, a two-year high (+15% mom and +12% versus 3QFY21).
We note that aluminium all-in prices are up 11% qoq in 4QFY21, resulting in a ~5% qoq increase in scrap spreads. We estimate that scrap spreads form almost a third of Novelis margins and higher spreads suggest further sequential margin expansion in 4QFY21.
The outlook shared by all major can sheet producers in their recent earnings commentary is consistent will that shared by Novelis management. There is strong structural tailwinds witnessed by the beverage can sheet segment led by market share gains from other packaging materials. Further, the auto sheet demand remains buoyant due to increasing penetration of EVs, SUVs and trucks. Aerospace is facing headwinds due to destocking in the supply chain.
At Novelis, favourable scrap spreads and tight end-use segments should keep margins above the management guidance of US$480-500/ton range and drive further earnings upgrades. We forecast margin of US$493/500 ton in FY2022/23E.