The Hindu Business Line : Nalco: Hold

Investors can consider retaining their exposure to the National Aluminium (Nalco) stock. At its current price of about Rs 195, the stock trades at a multiple of about seven times the likely 2006-07 earnings.

Though the valuation appears attractive, concerns about the company's sales mix, constraints on volume growth and a lower share of value-added products compared to its peer — Hindalco — underpin our tempered view on the stock.

Riding on the back of higher aluminium and alumina prices, Nalco came out with a strong set of numbers in the June quarter. While revenues rose 50 per cent, net earnings more than doubled.

In a firm-pricing environment, realisations rose steeply — that on alumina and aluminium jumped 125 per cent and 35 per cent respectively. This had a strong positive impact on the operating profit margin, which expanded by about 1,200 basis points to 58 per cent.

Debt-free status

Nalco's financial profile has also improved significantly over the last few years. Through a capital restructuring exercise, the company has been able to clean up its balance-sheet and attain a debt-free status.

This offers considerable room for it to borrow. Further, with healthy cash flow from operations, Nalco is well-placed to fund its ongoing expansion projects.

Nalco, which now derives about 70 per cent of its alumina sales through the spot market, has benefited immensely from the rising spot prices over the last few quarters.

Prices, however, have corrected from the level of $600 a tonne in April to about $400 now. With fresh alumina supplies expected to come in over the next year or so from China, Brazil, Australia and India, the pressure on supply is likely to ease.

Alumina prices

We expect alumina prices to remain in the $450-500 a tonne range over the medium term. Nalco's high exposure to the volatile spot prices makes its earnings vulnerable to any downward pressure on prices.

In the case of aluminium, we believe the sector fundamentals are in tact and expected to remain so over the next year or two. Rising costs of fuel are likely to exert pressure on producers across the globe, forcing them to adopt a firm pricing strategy.

Further, the bigger threat of Chinese supplies leading to an overhang in the global aluminium market has receded significantly, following Beijing's measures to curb exports.

We expect the market for aluminium to remain in deficit over the medium term, thereby lending greater visibility to firm prices.

Nalco, which is now operating to near-full capacity, is unlikely to leverage the buoyant demand for the metal immediately. Its fresh capacities are expected to go on stream only in 2008-09. This is likely to limit its volume growth in the near term, making it a play on prices.

Nalco's limited presence in the downstream operations of the value chain vis-a-vis its larger peer, Hindalco, also remains a concern. Since realisations on value-added products are higher on an average, there is a possibility of Nalco losing out on this potential.

If the proposed divestment in Nalco happens, it is likely to be a strong positive. This would increase the free float to 23 per cent from the current 13 per cent and impart greater liquidity to the counter.

However, the proposal has met with roadblocks and as such uncertainty looms over this issue. Any divestment-related gains thus appear unlikely in the near term, and have not been factored into our recommendation.

More Stories on : Stocks | Recommendation | Aluminium | National Aluminium Co. Ltd

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page