Nalco --Upgrading to Neutral  Changes to forecasts: Macquarie Research,

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Nalco
Upgrading to Neutral
Event
 Changes to forecasts: Our global commodities team has increased its
assumption on aluminium prices as it believes that the overhang of an interest
rate increase and liquidation of inventory is now slightly lower. We are
upgrading Nalco to Neutral from Underperform and maintain TP at Rs72.
Impact
 Increasing aluminium and alumina price forecasts: Our global commodity
team has increased its aluminium price forecasts for FY12 by 1% to
US$2,572/t and for FY13 by 10% to $2,662/t. We have also increased our
alumina price forecasts for FY12/13/14 by 2%, 13% and 3%, respectively, to
$384, $383 and $385/t.
 Global currency forecasts: Our economic team has also changed USD/INR
forecast for FY12 from 44.3 to 46.3, FY13 from 43.2 to 45.8, and FY14 from
41.8 to 44.2. These changes have also been built into our revised
assumptions.
 Changing estimates: We raise our earnings estimates for Nalco to reflect
upgrades to aluminium price assumptions and changes in our currency
estimates. However, the company continues to face problems in sourcing coal
for its CPP and has recently shut 60 of its pots due to unavailability of coal.
These issues will continue to be an overhang, in our view.
 Profitability depends heavily on coal mines: Though Nalco’s expansion
plans are now on stream, it is yet to start development of its Utkal coal mine
and expects coal from this mine to be available in the next two years. Given
constraints on supply from Coal India, margins can come under pressure in
the absence of captive coal.
Earnings and target price revision
 We have raised our EPS estimates for FY3/12/13/14 by 12%, 35% and 11%,
respectively.
Price catalyst
 12-month price target: Rs72.00 based on a Price to Book methodology.
 Catalyst: Resolution of coal problems
Action and recommendation
 Upgrade to Neutral: The stock has corrected very sharply (44% from the
peak) in the past few months due to worries on coal availability. However, this
correction has placed the assets in fair value zone. While we expect Nalco’s
stock to recover, we continue to see limited upside. We would recommend
Hindalco (HNDL IN, Rs147, OP, TP: Rs259), which in our view has a better
hedge for its earnings as well as a better growth profile, with access to raw
materials.