The Hindu Business Line : National Aluminium: Hold

SHAREHOLDERS can consider retaining their exposure in the National Aluminium Company (Nalco) stock at the current price levels. Since the stock has run-up sharply, fresh exposure can be avoided for now. Any divestment-related gains do not appear likely in the near term.

Improved financial profile, positive demand outlook from user segments, low-cost advantage that would weather price decline (if any) to a larger extent compared to its peers and gains from capacity expansion, offer scope for appreciation in the medium term. At the current price, the stock trades at a price-earnings multiple of about eight times the FY-06 earnings.

Financial highlights

Nalco's financial performance over the past five years has been fairly impressive. While the revenues posted a CAGR of about 15 per cent, earnings grew 18 per cent during the period. By integration its value chain, the company has established itself as one of the lowest cost producers in the world. The operating profit margin (OPM) has been around 45 per cent, well above the industry average. For the year-ended March 2005, revenues grew 33 per cent and earnings 67.5 per cent. This was primarily on account of higher aluminium prices and a greater share of exports, resulting in higher realisations.

For the quarter ended June 30, Nalco's performance has not been so encouraging on a sequential basis. While the revenues dipped 18 per cent, profits-after-tax fell 33 per cent. Weakness in global metal prices and the subsequent price-cuts of 3-4 per cent by the company may be attributed to this.

Zero-debt status

The company has been able to clean up its balance-sheet and reduce financial risk by a capital restructuring exercise. It has completely repaid its Rs 650-crore loan by March 2005, thereby becoming a debt-free company. This is likely to release cash for funding its proposed expansion and improve its profitability with the interest outgo reduced.

Expansion-linked gains

After completing the first phase of capacity expansion, Nalco started on the second phase, which is expected to be completed by FY-08. The second phase of expansion will increase Nalco's bauxite mining capacity to 63,00,000 tonnes (from 48,00,000 tonnes now); alumina production to 21,00,000 tonnes (15,75,000 tonnes), aluminium production to 4,60,000 tonnes (3,45,000 tonnes) and power generation to 1,200 MW (960 MW). The total cost of Rs 4,100 crore is to be funded in the debt-to-equity ratio of 1:1; the entire equity to be raised internally. The expansion is likely to result in greater economies of scale and bolster volume growth.

Contribution from exports

The company derives about 50 per cent of its revenues from export of alumina and aluminium. Higher realisations on exports have helped the company improve its revenues and margins.

While the export of alumina for the quarter-ended June 30 rose 12 per cent, aluminium exports fell 4 per cent. This was on the back of build-up of inventories in China and slackening of demand during the period.

Demand to remain high

The demand for aluminium is likely to remain on the high side considering the encouraging outlook for its end-user industries such as electrical, automotive, construction, consumer durables and packaging.

Though the demand growth may not be of the kind witnessed in 2004, it is likely to be in the 6-8 per cent range over the next two-three years.

The company mainly produces ingots, which form the raw material for secondary producers in the domestic market.

The fragmented nature of the secondary market along with the low bargaining power of players would make it relatively easier for the company to pass on the increase in costs, if any.

Key concerns

Nalco's presence in the downstream operations of the value chain is low vis-à-vis its peers. Since realisations on the value-added products are higher on an average, it may be a handicap and deter profitability. However, with the commissioning of the rolling mill in September, the share of value-added products is likely to improve.

The Government is considering removal of the core status for the aluminium and paper segments for coal linkages. If this happens, the hike in coal prices would put pressure on the input costs.

With supply likely to remain tight in the near term, higher import of coal may have a negative impact on margins.

Lower-than-expected demand growth in the user segments, appreciation in the rupee and softening of aluminium prices also remain risks to the company's business and, hence, our recommendation.

In the light of all the factors, remaining invested appears a prudent course.

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