Like many of its public sector peers, Nalco is a debt-free company with a dominant position and strong cost advantage in the domestic industry and has drawn up big, long-term growth plans. However, Nalco’s planned follow-on public offering (FPO) this year may not elicit huge response (unless the pricing is attractive) given the muted volume growth and metal pricing outlook (for aluminium). Among the few positives is that alumina volumes are estimated to increase while lower costs should help prop up margins, both of which are factored in the current share price.
The government’s holding in Nalco currently stands at 87.15 per cent, and a 10 per cent dilution (to 77.15 per cent) at current market price of Rs 62 could fetch about Rs 1,600 crore.
Analysts also believe that valuations are slightly higher at over 13 times earnings and six times enterprise value to operating profits based on 2012-13 estimates. From a longer-term perspective though, stock valuations appear a bit reasonable considering the cash in the books. Currently, Nalco has cash and investments worth Rs 4,900 crore. And, by end of 2012-13, this would rise to about Rs 6,000 crore, which is about two-fifths of its current market capitalisation (so, adjusted PE is about 8.7). However, the flip side is that lots of cash also suppresses return ratios, which the Street is usually wary about. In fact, return ratios for Nalco have been unexciting (return on net worth is in single-digits) in the last two to three years. This large cash has helped earn interest income, which has formed a large part of Nalco’s profit in recent times, and suppressed overall returns.
| MUTED TOPLINE GROWTH | |||
| In Rs crore | FY12 | FY13E | FY14E |
| Sales | 6,612 | 6,726 | 7,109 |
| OPM (%) | 17.0 | 24.0 | 22.0 |
| Net profit | 850 | 1,212 | 1,219 |
| EPS (Rs) | 3.3 | 4.7 | 4.7 |
| PE (x) | 18.7 | 13.1 | 13.1 |
| RoE (%) | 7.0 | 10.0 | 9.0 |
| RoE is return on equity/shareholders’ funds Source: Fullertone Securities & Wealth Advisors | |||
In this backdrop and given that the near-term business outlook is not exciting, gains for the investors (and hence their response) will largely depend on the FPO pricing (read discount to market price).
Sound business model
On the business front though, there is no doubt about Nalco’s relatively strong position. It is a leading integrated player in the domestic aluminium industry having cost advantage even compared to many of its global peers, thanks to its captive mines.
Take the recent case of global aluminium prices, which have corrected from about $2,700 per tonne in April 2011 to currently at around $1,930-1,960 a tonne. This has led global companies to cut production as some of them are incurring losses at the current prices. So far, though, Nalco has been operating profitably (albeit at lower margins) given that its cost of production works out to around $1,850-1,900 per tonne. However, if prices fall further, the pressure on margins will also increase, chances of which are slim as analysts say that over half of the world aluminium capacity is already operating at a loss.
Muted volumes
Aluminium prices nevertheless are critical for Nalco because there is not much scope for volume growth in the medium term. Though the company has huge expansion plans involving an investment outlay of about Rs 50,000 crore, progress on the same has been a cause of worry, say analysts. “Most of these expansions have not made any meaningful progress and are still in the conceptualisation stage. None of the projects are likely to get commissioned over the next four to five years. Hence, we expect volume growth to be muted beyond recently expanded capacities,” says Chirag Shah of Barclays in a recent report on the company. Analysts largely expect Nalco’s aluminium volumes to remain at current levels of 416,000-414,000 tonnes per year.
However, there could be some gain from the recently added alumina capacity, which is up 0.5 million tonnes to two million tonnes per annum. The company has said that most of these additional capacities will be targeted towards the international markets where realisations are better. This will help its sales to grow by about 7-10 per cent over the next two financial years. However, if aluminium prices improve from the current levels the growth in revenues will be higher.
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Operational gains likely
Contrary to sales growth, profit growth is expected to be better at over 30 per cent led by operational gains. Last fiscal, the drop in margins was among key concerns and impacted the stock, which is down almost 50 per cent since March 2011.
Due to rising energy costs, the company’s margins fell sharply to 17 per cent in 2011-12 from 25 per cent in 2010-11. Power and fuel costs have been a bane for Nalco having more than doubled since 2006-07 from Rs 855 crore to Rs 1,788 crore in 2010-11 even as its revenues remained virtually flat at around Rs 6,400 crore levels during this period. In 2011-12, too, these costs jumped 24 per cent to Rs 2,197 crore as compared to an 11.6 per cent increase in topline to Rs 7,154 crore.
Going ahead, the cost of energy is expected to come down as analysts are expecting coal supply from Coal India to improve, in addition to the ongoing correction in international coal prices. On the back of this, it is expected that Nalco’s operating profit margins (excluding other income) could restore to around 22-24 per cent, leading to better earnings, going ahead, though still lower than 2010-11 levels. Nevertheless, these gains are largely factored in the current stock valuations.
Divestment series concluded