Jaguar's (F ) new XK sports car, due to hit showrooms early next year, goes 155 miles per hour and looks neat enough. What distinguishes it, though, is its aluminum body, so stiff it also serves as the chassis. As much as auto buffs may admire this lightweight, monocoque design, the new XK is an absolute dream machine for a new company called Novelis (NVL ).
If that name rings no bells, don't worry. Novelis might be mistaken for Novartis, Novell (NOVL ), or Novellus Systems, even though it boasts greater annual sales than more familiar names including Avon Products (AVP ) or Phelps Dodge (PD ) (table). Yet Novelis is worth getting to know, and not just because of its choice role as supplier of aluminum sheet for the new XK, not to mention Jaguar's XJ sedan. Based in Atlanta, Novelis was spun off in January by Alcan (AL ), the giant Canadian integrated aluminum producer. By August, the stock had worked its way upward, to nearly 29, before a weak second-quarter earnings report sent it plunging. At recent prices under 20, however, Novelis looks to have far more upside than down.
I VENTURE THAT VIEW because, for starters, Novelis is a member of one of the worst-performing groups of stocks this year. Alcan, Alcoa (AA ), and the other aluminums together are down an average of 21% in 2005. (To find out why, look to the sharply higher costs for energy, a chief aluminum input, and the damping effect on aluminum prices of supplies from China.) Novelis, however, doesn't fit neatly into this group of stocks. Its business is concentrated not in production of aluminum ingots but in rolling the basic metal into huge coils that then can be cut, stamped, and shaped into food and beverage cans, construction materials such as home siding, foil for food packaging, sheets for printing plates, and, yes, for high-end auto parts. The latter include bodies for Jags, along with hoods and a bunch of other panels for the Mercedes-Benz (DCX ) S Class, Audi's new Q7 sports-utility vehicle, and more.
So, while rising energy costs indisputably weigh on Novelis, a key to its strategy is to keep a better grip on the pricing of its own products than the commodity metals makers do on theirs. One such initiative is its goal of reducing the proportion of total sales, now 20%, whose contracts include metal-price ceilings. These bar Novelis from passing on to food and beverage can customers higher costs for the basic metal. "We are very focused on getting" those limits out of new contracts as old ones expire, a Novelis spokeswoman told me.
Just the same, even the way business is operating today, Novelis is doing O.K. With the global economy expanding -- beyond North America, Novelis has vast operations in Europe, Asia, and South America -- sales last year rose nearly 25%, to $7.8 billion, with operating income jumping 34%, to $327 million. This year, Wall Street's consensus estimate is for a further 10% gain in revenues, with a small decline in operating income. More alluring to me is that Novelis is producing excess cash. Even after capital spending, which in the past 12 months ran $162 million, and $14 million in dividend payments -- the stock yields 1.8% -- Novelis still had $237 million in free cash flow.
Novelis's chief financial challenge is the nearly $3 billion in debt that Alcan saddled it with before the spin-off. Through this year's first half, Novelis had devoted $168 million of its free cash flow to reducing those obligations. Paying off still more debt remains a top priority. Novelis hopes within three or four years to have lowered the ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) from 5:1 to 3:1. As the debt goes down, the value of equity in Novelis goes up. At 20 a share, Novelis' market value is less than $1.5 billion, or six times the past four quarters' free cash flow. Chances are, that multiple will grow as investors get to know Novelis.