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Nalco: Linked to the cycle

Dec 1, 2001

Like its peers, the National Aluminium Company Ltd. (Nalco) scrip has engineered a smart comeback on the bourses. Much of this performance seems to be driven by the up-tick in international aluminium prices accompanied by a general shift in favour of equities. The BSE Sensex has climbed 26.7% since September 24 lows while Nalco has run up by 18.8%.

Aluminium prices have staged a smart rally post the World Trade Centre (WTC) incidents. Prices of the base metal, which ruled at $1,500 / tonne levels at the start of the fiscal, slid continuously to $1,350 / tonne levels by mid September before collapsing to their lows of $1,240 / tonne in November. Like all other commodities, aluminium suffered, as fears of more pronounced economic downturn and coercive action against the perpetrators severely dented business confidence. However, the difficult days seem to be a thing of the past, which seems to be reflected by the run in global equity markets. Aluminium prices have recovered from their lows rising by 12.4% to $1,400 / levels. All this suggests that along with the global economy, led by the U.S, the aluminium sector is likely to chart a recovery sooner rather than later.

Global demand for the metal over the next three-years is likely to grow at historical rates. Much of this growth is expected to come from China (demand grew by 17% in 2000), which is likely to offer better opportunities to Asian manufacturers. Going forward, the likely mismatch in global demand-supply, low inventory levels and closures of plants in the U.S could support a rise in aluminum prices.

Nalco seems to be a good play on the aluminum cycle, as alumina & aluminum are the largest constituents of the company's sales. In FY01, the above category contributed a shade above three quarters to the turnover. In fact, the primary aluminium division contributed to 57.5% of sales during the same period. That said, the statistic also indicates that the company does not have a significant presence in the downstream aluminium business. The extent to which Nalco can de-commoditise its business can be gauged from the fact that the refining & smelting contribution to sales of Alcoa, a leading global aluminium player, was 25% in 2000.

Another factor, which is likely to swing with trends in the global economy, is the company's strong presence in the export markets. In FY01, export sales, as percentage of gross turnover was 54.6%, which is 6.4% higher than FY00. Nalco is amongst the few Indian companies (excluding software services) that generate a greater share of sales from overseas. Again, profile of exports is skewed towards commodities with alumina & aluminium constituting 95% of export earnings. Competing in export markets, the company does not enjoy the benefits of any tariff barriers. Consequently, pressure on realizations could be greater. Also, they are likely to be more closely linked to international price trends. First nine months of the current calendar year proved challenging for Nalco, as breaks were put on global economic growth rates. But with exports the company is likely to benefit from any depreciation in the rupee.

1HFY02: Nalco not first among equals   

Net sales-3.2%0.9%10.1%
Operating profits-11.1%-5.4%1.3%
With greater dependence on the upstream business the corollary immediately comes to mind. Therefore, investors are likely to witness more volatility in the stock and should be alert of trends in the commodity cycle, as shifts in aluminium prices are likely to reflect on the company's financials. There could not be a better time to emphasize this point. Second quarter ended September '01, sales and post-tax profits (excluding extraordinary items) were down 18.2% and 26.4% respectively. Operating margins were bashed down 760 basis points. Non-ferrous metals was among the few sectors that disappointed markets.

Realising the cyclicality in business, the company seems to be taking steps to venture downstream, which could smoothen future earnings. The company has commissioned a 10,000 tonnes per annum (TPA), detergent grade zeolite plant at Damanjodi, Orissa (same location of alumina refinery). Although costlier, zeolite internationally is a preferred raw material in making detergents. This is due to the eco-friendly characteristics compared to the current ingredient sodium tri-poly phosphate (STPP). The company is campaigning for the phasing out or banning of STPP, a road tread by developed countries. In the interim, much of the sales are targeted to export markets. The company is also putting up a 26,000 TPA special grade alumina plant, which was to be commissioned by March '01 but is running behind by an estimated six months.

Nalco: Ongoing expansion programme
   Mining Refining Smelting Power
      7th Unit 8 Unit
Expanded capacity MMT 2.4 0.8 0.2 120 MW 120 MW
Aggregate capacity MMT 4.8 1.6 0.3 720 MW 840 MW
Estimated project cost Rs bn 1.2 12.9 16.3 4.2 4.5
Status   complete delayed delayed - -
Expected completion   - Jan '02 Nov '02 May '02 Feb '04

The company is a strong player in the aluminium business with fully integrated operations from mining to smelting and captive power. Consequently, it is amongst the lowest cost aluminium producers in the world. Also, the company has renewed its technical assistance agreement with Alumina Pechiney, France till 2003. With non-ferrous metals likely to chart a revival, the coming year for Nalco looks encouraging.

At the current market price Rs 50.1 the company trades on a multiple of 10.2x 1HFY02 annualised earnings. The stock usually trades on a multiple of 5x-6x earnings. The subdued profits have led to increased valuations and a reversal in earnings is likely to lead to valuations reverting to the mean. Consequently, the run in not likely to be unencumbered.

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