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Anand Rathi Securities has chosen NALCO as value pick
Edited by : AL CIRCLE
6 min read
Anand Rathi Securities has chosen NALCO as value pick. It has recommended `Buy` on NALCO for target price of Rs 90 (Time horizon: 24 months).
Prices to stabilize from Q4 2012
Aluminium prices have tumbled almost 30% in a year on worries about the strength of the global economy and thus potential industrial demand, particularly as the European sovereign-debt crisis continues. Aluminium prices have corrected sharply to below USD 2,109 a ton from a high of USD 2,807 in Q1 2011. Structural issues such as over-capacity and high inventories continue to be an overhang on aluminium prices. Few economic incentives to purchase aluminium have led to subdued aluminium imports from China as consumers focused on de-stocking.
In addition, excess aluminium production over demand since September 2011 has forced the fall in prices. According to Bloomberg consensus estimates, the LME benchmark price will stabilize in Q4 2012, then move up.
Alumina volumes to surge in FY13
NALCO currently has capacity to produce 0.46 million tons PA of aluminium and 2.1 million tons PA of alumina. In Q2 FY12, it expanded its alumina refining capacity, from 1.58 million tons PA. During the quarter it produced 30,000-40,000 tons of alumina.
However, no alumina from the new refinery was sold as, on a technical requirement, the company had to build stocks up to a particular level (40,000 tons) before selling the produce in the market. Only in Q3 FY12 will the produce be marketed and the company expects to sell, in that quarter, 30,000-60,000 tons of alumina from the new refinery. We expect production of alumina to increase from 1.6 million tons in FY11 to 1.75 million tons in FY12 and 1.90 million tons in FY13. We have kept our production target lower than the ``guidance`` to account for some shortfall in coal in the next two years.
We expect production of aluminium in the next two years to be flat. In FY11-12, it was lower due to coal shortages. During Q2 FY12, coal supplies from the Mahanandi Coal Fields were disrupted because of heavy rainfall in the region. NALCO received 70% of its coal from MCL, against an average of 80% for the year. As a result, the company had to import expensive coal and draw power from the state grid. This had led to a sharp jump in operating costs, as a result of which 120 pots had to be shut down. As coal supplies had been reduced, less metal was produced in the year. A drop in prices furthered the subdued aluminium production. Ahead, raw material costs to ease
Most of NALCO`s raw materials are sourced through annual contracts, generally agreed upon at the start of the financial year. For FY12, contracts were signed at prices higher than spot prices currently. The company has indicated that prices of raw materials such as caustic soda and CP coke rose 30% YoY in FY12. Since spot prices of these raw materials have declined in the last six months and are below the contract prices, we expect FY13 contracts to come at lower prices.
Raw material costs (as percent of sales) are expected to decline from 14% in FY12 to 12.4% in FY13. This would also be due to an increase in the proportion of sales of alumina (to total sales) in FY13. Revenue from sales of alumina is expected to increase from 17% in FY11 to 28% in FY13.
Power costs, the biggest culprit
In the past, NALCO has been vulnerable to rising coal costs and intermittent disruptions of supplies from the Mahanandi Coal Fields. In the past two years, supply from Coal India has been lower (84%, vs 90% earlier) due to the tight domestic demand-supply situation. NALCO also faces issues related to poor coal.
In FY12, it would be impacted as linkage coal supply has been further reduced and prices have been raised 30% at end-Feb. In Q2 FY12, linkage coal had been reduced to 70% from the average ``guidance`` of 80%. We believe that linkage coal supply would continue to decline on account of the tight coal supply situation in India. Power and fuel costs (as percent of sales) rose sharply by an average of 30% in the last two years, to 39% in FY 11-12.
The cost of power cost has been the major factor in dragging down the operating margin.
Capex to pave the way to growth
India can produce 2.7 million tons of aluminium, or nearly 5% of global production. The country has large bauxite reserves that could for over 350 years (at present rates of production).
To increase capacity, the company plans to invest Rs.23.43 billion (USD 478 million) next fiscal. This is a 76% rise in capital expenditure over the previous year.
NALCO plans to invest Rs 579.03 billion by 2020, mainly to establish two aluminium smelters. It plans to put up a 5-million-ton smelter in Indonesia, together with a 1,250-MW plant, at an investment of Rs.165 billion.
According to the company, another smelter together with a 1,260-MW plant would be set up in Western Orissa in two phases, at an investment of Rs.163.45 billion.
Consumption of aluminium in India is the lowest globally
Per-capita consumption of aluminium in India is less than 1kg. In the US and Europe it is 25-30kg; in Japan, 15kg; in Taiwan, 10kg; in China, 3kg.
Despite the lower per-capita consumption in India, demand for aluminum from several domestic industries is heavy, including fro the Power sector, which accounts for 44% of demand; consumer durables and transportation, about 10-12%, with construction and packaging about 17%.
The top-three in aluminium in India are the public-sector NALCO and HINDALCO, and the private-sector Vedanta Resources.
Valuation
In the last six months, NALCO`s stock has corrected almost 50% on account of weak commodity prices and subdued results. In the last three years, performance has been poor due to disruptions in coal supply from MCL.
The company has cash and cash equivalents of Rs. 22 a share on the books, representing 37% of the present market price. The stock now quotes at a P/BV of 1.3x, the lower part of the sevenyear median band. In the past, it has traded in a range of 2.1x to 3.3x. We believe that at the ruling price, the stock is very attractive to a long-term investor. We have valued it at the lower part of the P/BV band, i.e., 2.1x. From current levels, we do not see much downside and recommend buying it with a 24-month target of Rs.90.
Prices to stabilize from Q4 2012
Aluminium prices have tumbled almost 30% in a year on worries about the strength of the global economy and thus potential industrial demand, particularly as the European sovereign-debt crisis continues. Aluminium prices have corrected sharply to below USD 2,109 a ton from a high of USD 2,807 in Q1 2011. Structural issues such as over-capacity and high inventories continue to be an overhang on aluminium prices. Few economic incentives to purchase aluminium have led to subdued aluminium imports from China as consumers focused on de-stocking.
In addition, excess aluminium production over demand since September 2011 has forced the fall in prices. According to Bloomberg consensus estimates, the LME benchmark price will stabilize in Q4 2012, then move up.
Alumina volumes to surge in FY13
NALCO currently has capacity to produce 0.46 million tons PA of aluminium and 2.1 million tons PA of alumina. In Q2 FY12, it expanded its alumina refining capacity, from 1.58 million tons PA. During the quarter it produced 30,000-40,000 tons of alumina.
However, no alumina from the new refinery was sold as, on a technical requirement, the company had to build stocks up to a particular level (40,000 tons) before selling the produce in the market. Only in Q3 FY12 will the produce be marketed and the company expects to sell, in that quarter, 30,000-60,000 tons of alumina from the new refinery. We expect production of alumina to increase from 1.6 million tons in FY11 to 1.75 million tons in FY12 and 1.90 million tons in FY13. We have kept our production target lower than the ``guidance`` to account for some shortfall in coal in the next two years.
We expect production of aluminium in the next two years to be flat. In FY11-12, it was lower due to coal shortages. During Q2 FY12, coal supplies from the Mahanandi Coal Fields were disrupted because of heavy rainfall in the region. NALCO received 70% of its coal from MCL, against an average of 80% for the year. As a result, the company had to import expensive coal and draw power from the state grid. This had led to a sharp jump in operating costs, as a result of which 120 pots had to be shut down. As coal supplies had been reduced, less metal was produced in the year. A drop in prices furthered the subdued aluminium production. Ahead, raw material costs to ease
Most of NALCO`s raw materials are sourced through annual contracts, generally agreed upon at the start of the financial year. For FY12, contracts were signed at prices higher than spot prices currently. The company has indicated that prices of raw materials such as caustic soda and CP coke rose 30% YoY in FY12. Since spot prices of these raw materials have declined in the last six months and are below the contract prices, we expect FY13 contracts to come at lower prices.
Raw material costs (as percent of sales) are expected to decline from 14% in FY12 to 12.4% in FY13. This would also be due to an increase in the proportion of sales of alumina (to total sales) in FY13. Revenue from sales of alumina is expected to increase from 17% in FY11 to 28% in FY13.
Power costs, the biggest culprit
In the past, NALCO has been vulnerable to rising coal costs and intermittent disruptions of supplies from the Mahanandi Coal Fields. In the past two years, supply from Coal India has been lower (84%, vs 90% earlier) due to the tight domestic demand-supply situation. NALCO also faces issues related to poor coal.
In FY12, it would be impacted as linkage coal supply has been further reduced and prices have been raised 30% at end-Feb. In Q2 FY12, linkage coal had been reduced to 70% from the average ``guidance`` of 80%. We believe that linkage coal supply would continue to decline on account of the tight coal supply situation in India. Power and fuel costs (as percent of sales) rose sharply by an average of 30% in the last two years, to 39% in FY 11-12.
The cost of power cost has been the major factor in dragging down the operating margin.
Capex to pave the way to growth
India can produce 2.7 million tons of aluminium, or nearly 5% of global production. The country has large bauxite reserves that could for over 350 years (at present rates of production).
To increase capacity, the company plans to invest Rs.23.43 billion (USD 478 million) next fiscal. This is a 76% rise in capital expenditure over the previous year.
NALCO plans to invest Rs 579.03 billion by 2020, mainly to establish two aluminium smelters. It plans to put up a 5-million-ton smelter in Indonesia, together with a 1,250-MW plant, at an investment of Rs.165 billion.
According to the company, another smelter together with a 1,260-MW plant would be set up in Western Orissa in two phases, at an investment of Rs.163.45 billion.
Consumption of aluminium in India is the lowest globally
Per-capita consumption of aluminium in India is less than 1kg. In the US and Europe it is 25-30kg; in Japan, 15kg; in Taiwan, 10kg; in China, 3kg.
Despite the lower per-capita consumption in India, demand for aluminum from several domestic industries is heavy, including fro the Power sector, which accounts for 44% of demand; consumer durables and transportation, about 10-12%, with construction and packaging about 17%.
The top-three in aluminium in India are the public-sector NALCO and HINDALCO, and the private-sector Vedanta Resources.
Valuation
In the last six months, NALCO`s stock has corrected almost 50% on account of weak commodity prices and subdued results. In the last three years, performance has been poor due to disruptions in coal supply from MCL.
The company has cash and cash equivalents of Rs. 22 a share on the books, representing 37% of the present market price. The stock now quotes at a P/BV of 1.3x, the lower part of the sevenyear median band. In the past, it has traded in a range of 2.1x to 3.3x. We believe that at the ruling price, the stock is very attractive to a long-term investor. We have valued it at the lower part of the P/BV band, i.e., 2.1x. From current levels, we do not see much downside and recommend buying it with a 24-month target of Rs.90.
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