Stock Fundamentals

Why NALCO buyback offer is a good opportunity to exit

Satya Sontanam BL Research Bureau | Updated on February 06, 2021

Given the longer gestation period for capex, current valuation justifies tendering the shares

National Aluminium Company (Nalco) announced a ₹749-crore buyback offer on January 27. The company aims to buy back 6.98 per cent of the total shares at ₹57.5 per share (now at ₹50.2) through a tender offer. Nalco’s board fixed February 8, 2021 as the record date for the purpose of determining the entitlement and the names of shareholders who are eligible to participate in the buyback.

Nalco, which significantly derives its income from sale of aluminium and alumina (raw material for aluminium), last came out with buyback offer in October 2018 at ₹75 per share. The stock price never crossed that buyback price since then.

Should public shareholders tender their shares to Nalco in this offer? The answer seems yes. Here’s why.

Future capital returns in question

Nalco is known as a dividend stock with a payment history of more than ten years.

In this case, whether to hold or tender the share in the buyback should be based majorly on two factors. One, the ability of the company to reward shareholders through dividend/buyback in the future; two, the valuation of the stock at the buyback price, considering the future prospects of the company.

A look at the dividend pay-out by Nalco in the last few years reveals that while the company has paid alluring dividends to its shareholders in some years, it has done so inconsistently. From FY16 to FY20, the dividend yield each year has been3.5 per cent, 4.9 per cent, 10 per cent, 10 per cent and 2.6 per cent (calculated based on buyback price of ₹57.5).

Drop in the dividend payout for FY20 (₹1.5 per share) is attributed significantly to the weak performance of the company during the year on the back of poor global prices of both alumina and aluminium. The buyback of about ₹ 500 crore in FY19, would have also deterred the company in paying higher dividend in FY20 to its existing shareholders.

It is pertinent to note that the total dividend paid by Nalco for FY19 and FY20 was much more than the net profit earned during the respective periods. For instance, the dividend paid for FY19 was 161 per cent (pay-out ratio) of its earnings. This is slightly concerning

Inconsistent dividend payment history and a pay-out ratio above 100 per cent in the recent past are not good signs in case of a dividend-paying stock. Also, with the current buyback offer of ₹750 crore and high capex plans (per recent news reports, ₹30,000 crore estimated till FY27-FY28) of the company in the future blurs the prospects of healthy dividend payment in the future.

To give a perspective, the net cash of the company decreased from Rs 5,164 crore by the end of FY16 to Rs 1,968 crore by March 31, 2020.

Longer gestation for capex

In terms of valuations of the company, Nalco has been currently trading at 50 times its trailing twelve-month earnings. While the price to forward earnings (FY22), as per Bloomberg estimates, stand at 10 times at the buy back price. However, in our opinion, the estimated earnings for FY22 appear overly optimistic as it assumes a over 140 per cent growth in EPS (vs revenue growth of just 6 per cent) over FY21.

The company is in the process of expanding production capacity in its alumina refinary plant. It is also envisaging aluminium downstream projects such as an alloy-wheel plant and a value-added rolled products plant to improve realisations and insulate them from LME prices. This is still in the first phase of development and would take more than three years to operationalise.

Considering that the capex plans of the company will bear fruit only in the next three to four years, the valuations look stretched at this point. Also, with the huge capex requirement for the company going ahead (₹ 30,000 crore), the company now opting to return surplus cash to shareholders and prefer leverage (which looks inevitable to meet capex) suggest a poor capital allocation.

Also, any scope for an uspide in the near term would depend on alumina prices moving up. While the aluminium segment has less to provide to the profitability of the company in the near future due to its high cost of production, the alumina segment, which contributes about 35 per cent to the revenue and also the only profitable segment in the company with operating profit (PBIT) at 18 per cent, may give a leg-up to the operational performance of the company if the global alumia prices move up. However, global alumina prices are unpredicatble in nature owing to its dependance on various factors related to alumina as well as aluminium.

Considering the above factors, investors having two- to three-year time horizon may consider tendering the shares in the buyback.The acceptance ratio also plays a role in deciding how much of your holdings you can actually sell. Nalco’s buyback offer of 6.9 per cent of total shares implies that about 6.9 in every 100 shares could possibly be accepted under the buyback scheme, subject to conditions.

Published on February 06, 2021

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