Sell Nalco -Can aluminium prices breathe life?, Macquarie Research,

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Nalco
Can aluminium prices breathe life?
Event
 3Q results well below estimates: Nalco reported 3Q results below our
estimates due to higher-than-expected costs. We maintain our Underperform
rating and target price of Rs293. The stock continues to remain what we think
is excessively expensive, and we recommend a switch to Hindalco (HNDL IN,
Rs229.40, OP, TP: Rs286), which is our preferred aluminium play.

Impact
 Strong 3Q results, but impacted by costs: Net sales at Rs14.3bn were up
3% YoY, as higher alumina sales volumes compensated for lower realisation
of aluminium prices, which lagged increases in LME during 3Q. Costs per ton
were up 8% YoY and QoQ because of higher employee and raw material
costs. EBIDTA, at Rs3.7bn, is up 40% YoY and 15% QoQ. Net profit, at
Rs2.5bn, is up 65% YoY and 14% QoQ.
 FY11 earnings have 5–6% downside risks:  Nalco has achieved 63% of our
full-year estimates in the first nine months, and we believe reaching our fullyear estimates is contingent on increasing alumina sales. The company is
increasing its alumina capacity from 1.6tpa to 2.1mtpa, and any delay in
commissioning can lead to a miss in full-year estimates.
 High sensitivity to aluminium prices can benefit in short term: Our global
commodities team believes that aluminium prices could remain strong in the
short term (our estimate is $2,645/t for 4Q FY11) due to lower production in
China and strong demand, which could help Nalco report good results.
However, in the medium term aluminium remains a highly oversupplied
surplus commodity and possible liquidation of inventory remains a key
overhang.
 Bonus and stock spilt announced: Nalco has announced a stock split of 1:2
and has also announced a bonus issue to the existing shareholders of the
company in the proportion of 1:1. We believe that this should improve liquidity
of the stock and could lead to better price discovery and to correction of the
stock.
Earnings and target price revision
 No change.
Price catalyst
 12-month price target: Rs293.00 based on a Price to Book methodology.
 Catalyst: Lack of volume growth and decline in aluminium prices.
Action and recommendation
 Maintain Underperform: Though strength in aluminium prices can be a
positive catalyst for the company, the stock looks extremely expensive to us,
trading at an 18x PER on FY12E and 2.0x P/BV. The company’s high
valuation continues to baffle us, and we would recommend a switch to
Hindalco, which has a better hedge for its earnings and abetter growth profile.
We maintain our Underperform rating.