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Nalco: Disappointing quarter - Views on News from Equitymaster
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Nalco: Disappointing quarter
Oct 29, 2005

Performance Summary
Nalco, the leading alumina and aluminium player in the country, announced its 2QFY06 numbers just a short while ago. The company’s performance at the topline as well as the bottomline has been substantially poor with these recording 7% and 3% YoY growth respectively. Operating margins also came under significant pressure that took its toll on the operating profits of the company, which have declined during the quarter. However, the significant reduction in other financial charges helped save the bottomline from registering a negative growth.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net Sales 9,769 10,470 7.2% 17,992 20,257 12.6%
Expenditure 4,657 5,881 26.3% 8,496 10,773 26.8%
Operating Profit (EBDITA) 5,112 4,589 -10.2% 9,496 9,484 -0.1%
EBITDA margin (%) 52.3% 43.8%   52.8% 46.8%  
Other income 589 474 -19.6% 1,006 880 -12.5%
Interest 173 -   346 -  
Depreciation 1,135 992 -12.6% 2,266 1,975 -12.8%
Profit before tax 4,393 4,070 -7.3% 7,891 8,389 6.3%
Tax 1,638 1,240 -24.3% 2,945 2,753 -6.5%
Profit after Tax/(Loss) 2,755 2,830 2.7% 4,945 5,636 14.0%
Net profit margin (%) 28.2% 27.0%   27.5% 27.8%  
No. of Shares (m) 644 644   644 644  
Diluted earnings per share* 17.1 17.6   15.4 17.5  
Price to earnings ratio (x)   8.7     8.7  
(* 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 2QFY06?
Poor topline show: Nalco reported a mere 7% YoY growth in topline during the quarter. While the company does not provide any volume sales numbers, production of alumina and aluminium during the quarter were higher by 3% and 9% YoY respectively. Further, it must be noted that average aluminium prices during the quarter were higher by 8% over the same quarter of the previous fiscal. Also, on the alumina front, despite the volatility in alumina prices, the average alumina prices in 2QFY06 have remained strong. Considering all of the above, the slower topline growth seems largely to be a factor of the high base of 2QFY05. It must be noted that in 2QFY05, Nalco had reported a topline growth of 21%, which was aided by 19% higher average aluminium prices during that quarter.

Cost break-up (% of net sales)
  2QFY05 2QFY06 1HFY05 1HFY06
Inc/Dec in stock in trade -3.3% -4.5% -7.9% -10.5%
Raw material consumed 10.8% 13.5% 19.5% 24.4%
Power & Fuel 19.6% 24.9% 36.9% 45.1%
Repairs & maintenance 4.9% 5.6% 8.7% 9.7%
Other Mfg. Expenses 3.4% 3.5% 6.5% 7.7%
Staff costs 7.3% 7.1% 14.0% 14.9%
Administration expenses 3.6% 3.3% 6.3% 6.3%
Selling & distribution exp. 1.4% 2.7% 2.9% 5.3%
Total expenses 47.7% 56.2% 87.0% 102.9%

Operating margins tumble: Margins came under immense pressure during 2QFY06 as they tumbled 850 basis points compared to 2QFY05. As can be seen in the table above, this was largely owing to a substantial increase in raw materials and power & fuel expenses. It must be noted that while the former contributes to over 20% of the total operating expenses, the latter forms another 40%+, thus these two together constituting over 2/3rd of the total operating expenses of the company. Further, seemingly, while caustic soda and calcined petroleum coke prices would have affected raw material expenses as these contribute a major chunk, power and fuel expenses were higher owing to higher coal prices. Repairs and selling and distribution expenses also added to the woes. All of this led to the operating profits being lower by 10% YoY during the quarter.

But, bottomline holds: Despite the dismal operating level performance and a 20% YoY fall in other income, the bottomline during the quarter was higher by 3% YoY. This was on account of various reasons. While for one, the company’s debt-free status helped matters, as there was no interest expense during 2QFY06 ((Rs 173 m in 2QFY05). This coupled with lower depreciation charges (down 13% YoY) and significantly lower tax incidence at 30% compared to about 37% in 2QFY05 helped save the bottomline.

What to expect?
At Rs 153, the stock is trading at a price to earnings (P/E) multiple of 13.6x our estimated earnings for FY08 and a price to book value (P/BV) of 1.4x. These valuations leave little room for upside for the stock. Further, at the current juncture, since we do not foresee aluminium prices to remain strong right throughout FY07 and also in FY08, we remain apprehensive about the sustenance of the strong performance by the company going forward.

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