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Nalco: Respectable performance - Views on News from Equitymaster
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Nalco: Respectable performance
Jul 25, 2005

Performance Summary
Nalco, the leading alumina and aluminium player in the country, announced respectable 1QFY06 numbers. While the company’s topline continued to register growth rates in double digits aided by the buoyancy in the aluminium market, operating margins came under pressure during the quarter. However, lower financial expenses helped the bottomline outperform the topline growth.

(Rs m) 1QFY05 1QFY06 Change
Net Sales 8,223 9,787 19.0%
Expenditure 3,839 4,892 27.4%
Operating Profit (EBDITA) 4,384 4,896 11.7%
EBITDA margin (%) 53.3% 50.0%  
Other income 417 406 -2.5%
Interest 173 -  
Depreciation 1,131 983 -13.1%
Profit before tax 3,498 4,319 23.5%
Tax 1,308 1,514 15.8%
Profit after Tax/(Loss) 2,190 2,806 28.1%
Net profit margin (%) 26.6% 28.7%  
No. of Shares (m) 644 644  
Diluted earnings per share* 13.6 17.4  
Price to earnings ratio (x)   9.1  
(* annualised)      

India’s largest alumina player
Nalco is the largest alumina and second largest aluminium producer in the country. 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. Recently, the company 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 1QFY06?
Aluminium drives gains:  Nalco reported a 19% growth in topline for the quarter ending June 2005, which though lower than the past few quarters, is nonetheless respectable. The company continues to reap the benefits of the sustained global demand for the metal, which has helped keep both – alumina and aluminium – average prices higher than the corresponding quarter of last year. Higher volume sales and better price realisations have aided the company achieve this topline growth. While the company does not provide volume sales numbers, the fact that metal production was higher by about 19% YoY during the quarter, indicates that metal sales were considerably higher. However, increase in alumina production seems to be constrained by the fact that alumina capacity utilisation already is near 100%. The segmental revenue performance shows a 16% YoY and 18% YoY growth in chemicals and aluminium business segments respectively.

Cost break-up (% of net sales)
  1QFY05 1QFY06
Inc/Dec in stock in trade -5.5% -6.5%
Raw material consumed 10.4% 11.7%
Power & Fuel 20.5% 21.6%
Repairs & maintenance 4.5% 4.4%
Other Mfg. Expenses 3.7% 4.5%
Staff costs 7.9% 8.3%
Administration expenses 3.2% 3.2%
Selling & distribution exp. 1.8% 2.8%
Total expenses 46.7% 50.0%

Operating margins under pressure:  While operating margins have improved as compared to the previous quarter (4QFY05), on a YoY basis, these have come under pressure. Operating margins were lower by 330 basis points during the quarter as compared to 1QFY05. However, these have remained at about 50%, which is a comforting sign. The pressure on margins has come from almost all the operating heads, as can be seen in the table above.

Debt-free status aids bottomline:  The company achieved debt-free status in FY05, which is reflected in the absence of any interest expense component during the quarter under consideration. This, coupled with lower depreciation charges (down 13% YoY) and lower tax bearing, seemingly on account of the lowering of tax rate in the Budget, reflected in the 28% bottomline growth during the quarter.

What to expect?
At Rs 158, the stock is trading at a price to earnings multiple of 9.1 times its 1QFY06 annualised earnings. Further, as per our FY07 estimates, the stock is trading at 9.8 times its estimated earnings per share and 1.6 times estimated book value. These valuations leave little room for upside for the stock. However, it must b noted that the company’s June quarter performance has been largely in line with our estimates on almost all the fronts i.e. topline, operating margins and net profit margins and as such we will not be making any changes to our full year estimates.

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