Nalco: Liquidate in small lots

Recommendation: Liquidate in small lots

Krishnan Thiagarajan

`A PORTFOLIO with 60 different railway securities, for example, would not be as well-diversified as the same size portfolio with some railroad, some public utility, mining, various sort of manufacturing, and so on. The reason is that it is generally more likely for firms within the same industry to do poorly at the same time than for firms in dissimilar industries.' -- Markowitz in his book, Portfolio Selection: Efficient Diversification of Investment

At the current market price of Rs 59, the Nalco stock trades close to its 52-week high of Rs 64. Though the company's fundamentals are strong, the fourth quarter earnings performance for 2000-01 was disappointing to some extent.

Owing to an additional provision towards employee remuneration of Rs 25.20 crore and Rs 10.29 crore towards repair of fly ash pond and compensation to affected villagers, Nalco's operating profit margin for the fourth quarter was affected; it dipped by 9.83 percentage points to 37.67 per cent compared to the corresponding previous period.

The other uncertain variable which may affect Nalco is the international prices of aluminium. Although most analysts were expecting the price trends to remain firm through 2001, there are strong indications that the Asian region may not fully participate in these firm price trends. It is already witnessing signs of a slowdown in demand and narrowing aluminium premiums compared to the early part of the year. This may leave limited scope for upside in aluminium prices in the domestic market. Despite these two developments, Nalco's fundamentals are strong.

For the year ended March 31, 2001, the operating profit margins improved by one percentage point to 44.69 per cent vis-a-vis the previous year. Hence, shareholders with a long-term investment horizon may stay invested in the stock, while those with a shorter horizon may use every uptrend to liquidate in small lots. For the former, the growth prospects are expected to be dictated by three factors. One, the expansion of the bauxite mines and alumina refinery to help provide inputs to its expansion project for primary metal. The first phase of expansion of alumina refinery was completed in June 2000 and that enhanced the production capacity of the alumina refinery to 1.05 million tonnes from 0.80 million tonnes earlier. The final phase of expansion to 1.575 million tonnes of alumina refinery was completed recently.

In addition, the company has already doubled the bauxite mining capacity from 2.40 million tonnes to 4.80 million tonnes respectively. In completing this expansion, Nalco has paved the way for the second driver of its earnings growth. The company is implementing an expansion project involving the enhancement of its smelting capacity from 2.30 lakh tonnes per annum (tpa) to 3.45 lakh tpa, along with an increase in captive power capacity from 720 MW to 840 MW. The project cost is estimated at Rs 2,062 crore and is to be financed through a mix of debt and internal accruals. This project is scheduled to go onstream by May 2002.

Since Nalco had no downstream production in the past to create scope for value-addition, it decided to create its third engine of growth by taking over International Aluminium Products Ltd, a joint venture originally promoted by Mukand, FATA Hunter and Global Emerging Markets, a foreign investor.

Nalco had earlier held a 35 per cent equity stake in the venture, and this project, located adjacent to its smelter in Angul, Orissa, has a production capacity of 50,000 tonnes of rolled products. Nalco's management is now working towards obtaining the requisite approvals for the amalgamation of IAPL with Nalco.