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Alumina refinery expansion to drive RoCE
Upgrade to Neutral
Rise in cost of production depresses return ratios.
Over FY07-11 Nalco delivered ASR of only 3% despite average RoIC of 43%.
Consistently declining RoIC and IC/CE ratio dragged down RoCE.
Nalco's alumina refinery expansion will drive RoIC and RoCE.
We upgrade the stock to Neutral.
Rise in cost of production depresses return ratios
Over FY07-11, Nalco's cost of production (CoP) increased almost 75% to ~USD2,100/
ton due to rising operating costs. There has been huge cost inflation due to unavailability
of cheaper linkage coal from Coal India, rising maintenance costs due to aging smelters,
faster labor cost inflation than productivity improvement and rising commodity prices.
Nalco gets 70-80% of its allotted coal from Coal India and it procures the rest either
from e-auctions or imports, which raises costs. Per ton cost of coal used for its captive
power plant increased from USD13 in FY07 to USD30 in FY11. Employee cost per
ton of aluminum produced has doubled from USD242 in FY07 to USD484 in FY11.
Consequently, return ratios declined over FY07-11. RoIC peaked in FY07 at 82% and
fell sharply to 23% in FY11. RoE declined from 31% to 10% in FY11. RoCE declined
from 49% in FY07 to 13% in FY11 due to higher operating costs and lower LME
(aluminum declined from ~USD2,600 to USD2,200 in FY11).
Benefits of phase II expansion will drive earnings growth
Nalco invested ~USD1.1b over FY07-11 to increase smelter capacity from 345ktpa
to 460ktpa, boost captive power capacity from 960MW to 1,200MW and increase
alumina capacity from 1.6mtpa to 2.1mtpa under its phase II expansion. The balance
sheet has remained debt free with a cash surplus of USD1.1b. Commissioning of an
alumina refinery is behind schedule but Nalco expects to complete it in FY12. As
production of alumina increases, sales volumes will grow, driving revenue growth
Rising UnIC/CWIP
Nalco's UnIC/CWIP will increase from 35% in FY11 to 54% in FY13 due to an increasing
cash component and lower capex in the core business. Although Nalco is working on
several expansion projects in Indonesia and Orissa, on nuclear power and titanium, there
is little visibility of any of them being completed. Nalco's intention to get into unrelated
projects (even though through a JV partner) is worrisome.
RoIC, RoCE improve; Valuations attractive; upgrade to Neutral
Nalco will post earnings CAGR of 17% over FY11-13 due to strong growth in alumina
volumes and stronger alumina prices. Over the next two years, Nalco will generate USD1b
cash flow from operations and capex will be a mere USD100m. However valuations have
become attractive after the recent correction in stock price. Nalco will also benefit from a
depreciating rupee as it exports excess alumina and the alumina refinery expansion will
drive RoIC and RoCE. At CMP of INR 62, the stock trades at a 56% discount to NAV
and EV of 3.4x FY13E EBITDA. Risk remains from coal supply disruptions from Mahanadi
coalfield. We upgrade the stock to Neutral with a target price of INR77 based on 5x
FY13E EV/EBITDA.
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