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Nalco: Sustained momentum - Views on News from Equitymaster
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Nalco: Sustained momentum
Jan 27, 2006

Performance Summary
India’s leading alumina and aluminium player, Nalco, has declared its results for the third quarter and nine-month period ended December 2005. The company has reported a strong growth in topline as it continues to ride the strong wave being witnessed by the aluminium industry. Though operating margins have come under pressure, higher other income and the company’s debt-free status leading to ‘zero’ interest expense helped it to report a stronger bottomline growth. It must be noted that Nalco had announced an interim dividend of Rs 2 per share (dividend yield of 0.8%) in January 2006.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net Sales 10,901 13,249 21.5% 28,892 33,506 16.0%
Expenditure 4,980 6,604 32.6% 13,475 17,377 29.0%
Operating Profit (EBDITA) 5,921 6,645 12.2% 15,417 16,129 4.6%
EBITDA margin (%) 54.3% 50.2%   53.4% 48.1%  
Other income 408 545 33.5% 1,413 1,424 0.8%
Interest 151 -   496 -  
Depreciation 1,179 919 -22.1% 3,444 2,893 -16.0%
Profit before tax 4,999 6,271 25.4% 12,890 14,660 13.7%
Tax 1,939 2,341 20.7% 4,884 5,094 4.3%
Profit after Tax/(Loss) 3,061 3,930 28.4% 8,006 9,566 19.5%
Net profit margin (%) 28.1% 29.7%   27.7% 28.6%  
No. of Shares (m) 644 644   644 644  
Diluted earnings per share*       24.9 21.3  
Price to earnings ratio (x)         11.6  
(* trailing 12-month earnings)            

India’s largest alumina player
Nalco is the largest alumina and second largest aluminium producer in India. The company is amongst the lowest cost producers of the base metal in the world. It has a competitive edge vis-à-vis its peers due to factors like rich bauxite reserves, captive power plants and rail and port operations. The company derives more than 50% of its revenues from exports. Further, the company has received the approval from the Cabinet Committee on Economic Affairs (CCEA) for its Rs 41 bn expansion plan.

Nalco’s expansion plan entails the expansion of its mining capacity from the present level of 4.8 million tonnes to 6.3 million tonnes, the capacity of its refinery at Dhamanjodi from 1.6 m tonnes to 2.1 m tonnes, aluminium capacity from the current 345,000 tonnes to 460,000 tonnes and power generation capacity from 960 MW to 1,200 MW. The company intends to meet this cost of expansion of Rs 40 bn out of internal resources and to an extent from commercial borrowings. This capacity is likely to come on stream only during FY09.

What has driven performance in 3QFY06?
Strong realizations prop up topline: Riding firm on the back of strengthening aluminium and alumina prices, Nalco reported a 22% YoY growth in topline during 3QFY06. Sustained demand for the metal has resulted in shortage of the availability of alumina (raw material for aluminium), which has benefited alumina players like Nalco. The shortage has led to alumina prices firming up in the international markets. In fact, spot alumina prices have been trading close to US$ 600 per tonne in recent times. Further the aluminum supply situation has been affected on the back of shutdown of smelters in the Western countries owing to high power costs. This has helped aluminium prices to sustain near record levels. During the quarter, average aluminium prices on the LME were higher by 15% YoY.

Cost break-up (% of net sales)
  3QFY05 3QFY06 9mFY05 9mFY06
Inc/Dec in stock in trade -0.5% 3.7% -2.9% -1.8%
Raw material consumed 10.6% 10.9% 10.6% 11.9%
Power & Fuel 18.7% 17.7% 19.5% 21.1%
Repairs & maintenance 3.1% 4.0% 4.1% 4.6%
Other Mfg. Expenses 2.7% 2.0% 3.2% 3.2%
Staff costs 6.8% 6.4% 7.3% 7.2%
Administration expenses 2.3% 3.1% 3.0% 3.2%
Selling & distribution exp. 2.0% 2.1% 1.7% 2.5%
Total expenses 45.7% 49.8% 46.6% 51.9%

Operating margins under pressure: The operating margins during the quarter were lower by 420 basis points. However, taking a closer look at the break-up of the various operating cost heads (see table above), it can be noticed that most of the operating cost heads has remained stable as percentage of net sales. Though there has been a considerable increase in repairs and maintenance and administration expenses as percentage of net sales, these form a small component of the total operating expenditure. The lower margins during 3QFY06 have been largely owing to stock adjustments. However, on a QoQ basis, operating margins have registered a sharp increase.

Net profits surge: Net profits for the quarter were higher by 28% YoY. A 34% YoY rise in other income, absence of any interest expense during 3QFY06 (Rs 151 m in 3QFY05) and 22% lower depreciation charges helped the company registering the bottomline growth. For 9mFY06, the company has reported a 20% YoY growth in profits on the back of a 16% YoY growth in revenues. It must be noted that the nine-month performance of the company was affected by poor performance in 2QFY06.

Performance over the past few quarters…
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06 2QFY06 3QFY06
Net sales growth (YoY, %) 32.6% 21.0% 53.2% 25.2% 19.0% 7.2% 21.5%
Net profit growth (YoY, %) 85.1% 47.2% 83.2% 59.3% 28.1% 2.7% 28.4%
Operating margins (%) 54.0% 52.3% 54.3% 48.8% 50.0% 43.8% 50.2%

What to expect?
At Rs 248, the stock is trading at price to earnings multiple of 11.6 times its trailing 12-month earnings. Further, the stock is trading at 2.4 times P/BV on our FY08E basis, which we believe is expensive. While the company’s performance has been in line with our full year FY06 estimates and as such we will not be making changes to our numbers, considering the current strength in the aluminium cycle, we may have to upgrade our FY07 estimates. It must be noted the aluminium prices in the domestic markets increased considerably during 3QFY06, the entire effect of which would reflect in the ensuing quarters. Nonetheless, despite this, the stock continues to remain a risky proposition purely from the valuation point of view, though near-term momentum could be sustained in the stock owing to strong numbers expected over the next 2-3 quarters.

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