Nalco: Sell


Investors could consider selling their shares in aluminium producer Nalco given the fact that the company's expansion plans do not provide the company's top-line sufficient firepower for increased volume growth over the near-term. With aluminium metal prices expected to remain in a narrow range, top-line expansion will have to come mainly from volumes. Continual pressure on the input cost front too is crimping profit growth. Therefore, the stock's current market price of Rs.75 which is 18 times its FY11 earnings may prove to very hard to justify. Peers with more ambitious expansion plans or better product mix such as Hindalco and Sterlite trade at 13 and 11 times their FY11 earnings. On a enterprise value to operating profit basis, Nalco is at eight times also at a premium to larger global peers such as Alcoa and Norsk Hydro among others.

The year 2010-11 saw net sales and profits rise by 20 and 28 per cent to Rs 6,370 and Rs 1,070 crore respectively as higher global aluminium prices boosted sales. The company's net profits received a significant boost from locking into longer term raw material contracts whenever possible. However this is not an advantage the company is likely to enjoy this year. External factors such as the lacklustre pace of growth in domestic coal supply and the new profit-sharing clause in the Draft Mining Bill are likely to contribute to significantly higher coal prices over the medium-term. Coal is an input to the company's captive power plants which are a third of the cost of producing aluminium. The company's other inputs such as caustic soda, calcined petroleum coke and coal tar pitch have seen their prices rise at a far quicker pace than the six per cent gain registered by aluminium since the start of the year.

Aluminium prices face another headwind in the form of high global inventory. Global inventory stockpiles are estimated at 4.5 million tonnes or 12-15 per cent of the annual consumption. This stockpiled mass of aluminium is expected to keep aluminium prices in check. Further smelter additions and restarts in West Asia, China and developed countries have more than kept pace with the growing demand for aluminium. The company's own expansion plan includes the addition of 25 per cent to the current alumina production capacity and a commensurate increase in bauxite ore production. Given that alumina prices trade at roughly 14-15 per cent of the value of final aluminium, the upside from increased alumina volumes is unlikely to off-set the input cost pressure from running smelters. The company is a zero-debt entity with Rs 3,800 crore of cash in hand.

Published on July 30, 2011

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