National Aluminium -Focus now on alumina and coal ::, RBS,

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National Aluminium 
Focus now on alumina and coal 
NALCO reported 3QFY11 results that were below our expectations. Results appear
to have been impacted by a greater lag in pricing. We have cut our FY11/12F
earnings by 10%/6% as we factor in lower alumina volumes. Going forward, timely
expansion of alumina capacity to 2.3mt and the Utkal coal block are key.

3QFY11 EBITDA 19% below estimate 

Net sales at Rs14.2bn (-2% qoq and +3% yoy) was below our estimate of Rs15.7bn. 

Aluminium production at 110.9kt was flat qoq and yoy. The average LME aluminium price 

was up 12% during the quarter. EBITDA at Rs3.71bn (+15% qoq and +40% yoy) was lower 

than our estimate of Rs4.57bn. Net profit was Rs2.56bn (+14% qoq and +65% yoy) versus 

our estimate of Rs3.15bn. A greater than expected lag in price hikes at the company 

compared with benchmark prices appears to have had an impact on earnings. 

Rally in aluminium and move to index-linked Alumina prices positive for earnings 

The LME aluminium price has rallied from the June low of US$1,828/t and is now around 

US$2400/t. Our commodities strategy team believes aluminium offers one of the most 

attractive risk:reward commodity plays through to 2014 and forecasts an aluminium price of 

US$2,975/t in 2014. Also, with the creation of the Alumina index, we expect a gradual move 

towards index-linked alumina prices from aluminium-linked prices. This could potentially 

increase alumina prices to reflect the higher cost structure. Such a move would be positive 

for NALCO, given its significant alumina external sales. 

We cut our FY11/12 earnings estimates by 10/6%. Maintain Hold 

NALCO's alumina refining capacity has progressively met with delays and is now expected 

by management to be commissioned by 4QFY11. NALCO has been allotted the Utkal -E coal 

block and expects to start mining by June 2012. We have cut our FY11/12 earning estimates 

to factor in lower alumina sales. Timely alumina expansion and captive coal mining are key 

to future share price performance, in our view. We value NALCO based on a peer average of 

7.7x (from 7.5 earlier) on FY12F EBITDA to arrive at a target price of Rs365 (from Rs395). 

Maintain Hold.

Rally in aluminium to drive earnings growth 

The LME aluminium price has rallied from the June low of US$1,828/t and is now hovering around 

US$2,300/t. Prices have been supported by 1) lower supply from China due to smelter shutdowns 

to meet the government’s energy efficiency-related targets, and 2) the second round of 

quantitative easing in the US of US$600bn. Our commodities strategy team believes aluminium 

offers one of the most attractive risk:reward commodity plays through to 2014. It expects supply 

shortages post 2011 and forecasts a cumulative deficit of 2.5mt over the 2012-14 period. It 

forecasts an LME aluminium price of US$2,975/t in 2014. We estimate a 1% increase in LME 

aluminium prices would result in a 2.3% increase in NALCO’s FY12F earnings.

  

Industry move to Alumina index pricing would be positive 

Alcoa, the largest US aluminium producer, moved to pricing alumina based on a basket of indices 

in August 2010, away from the traditional model of linking to a percentage of the LME aluminium 

price. Over the last few years, alumina contracts have been priced at about 12-15% of the LME 

aluminium price. We expect a gradual move towards index-linked alumina prices away from 

aluminium-linked prices over the next few years. This could potentially increase alumina prices to 

reflect the higher underlying cost structure. NALCO sells about 60% of its alumina through longterm contracts and the remaining 40% through the spot market. We believe a move to index 

pricing of alumina would be positive to NALCO given its significant external sales. However, we 

note that this is likely to play out only in the medium-to-long term. We highlight that recent 

contracts have fetched higher prices for the company. In November, NALCO sold 180kt of 

alumina in a long-term contract for 2011 at 15.92% of the monthly average LME aluminium price 

on an FOB basis. In October, it sold 210kt for 2011 at 16.26% of the LME aluminium price. This is 

substantially more than the company has realised in the recent past (14-15%). 

Brownfield expansion of refinery to be completed by 

4QFY11 

NALCO completed the expansion of its brownfield aluminium smelting capacity to 460kt from 

345kt in 2009. Its alumina refining capacity, however, has progressively met with delays and is 

finally set to be commissioned by 4QFY11. The full capacity of refinery and smelter will be 

operational in FY12. All units of the expanded 1200MW captive power plant have also been 

commissioned and are set to start production. However, coal linkage will continue to be an issue, 

and management has indicated it will have a shortage of 1.3-1.4mt which will bet met through 

imports/e-auction. NALCO has been allotted the Utkal-E block for its captive power plant. Though 

forest and environmental clearances have been obtained, the land acquisition process is still 

ongoing and the company has indicated it could take until FY13-14 before mining can begin. We 

expect power costs to remain high until then. Clarity is yet to emerge on the company’s greenfield 

expansion plans and we remain cautious on the same. 

Revised model estimates; maintain Hold 

We reduce our external alumina sales assumptions for FY11/12 by 11%/5%. We increase our 

average blended alumina price realisation assumption by 6%/12% for FY11/12. We also factor in 

5% higher operating cost assumptions yoy and introduce our FY13 estimates. We estimate 

earnings growth of 29%, 50% and 10% for FY11-13. We value NALCO based on the current peer 

average of 7.7x (7.5x earlier) on FY12F EV/EBITDA to arrive at a target price of Rs365 (from 

Rs395). With the earnings momentum seemingly priced in, we maintain Hold.