National Aluminium Company: More in the ore

Mining and metal makers witnessed a reversal of fortune last year as metal prices rebounded sharply. Investors have sent metal stocks soaring, on expectations of better times ahead. The stock price of many metal majors trade at or near their all-time high valuation. Yet, investors with a long-term horizon can still buy them as their earnings are set to revive.

One such stock, which has good prospects even after nearly doubling in the last year is that of State-owned National Aluminium Company (Nalco). The company sells bauxite ore, alumina (processed ore) as well as aluminium metal. Its stock is not cheap; the current price of ₹73 discounts its trailing 12-month earnings by 26 times, compared with an average multiple of 16 times in the last three years. But it is still cheaper compared to its peer Hindalco (trading at 28 times).

Nalco is better placed compared to its peers, as it owns high-grade bauxite ore and coal blocks; its cost of alumina production is among the cheapest in the world. It also has a strong balance sheet (with cash balance of ₹4,600 crore as of September 2016). The company has also paid dividend consistently and the current dividend yield is 2.6 per cent. Nalco has good earnings prospects, boosted by global higher aluminium prices which translate into margin improvement and earnings growth. Investors with a two-year view can buy the stock as it is well positioned to benefit from improving prospects for the light-weight metal.

Projected increase in both demand (higher aluminium volume and prices) and supply (higher alumina sale volume and prices) should aid Nalco’s prospects as it is an integrated producer - ore (bauxite), refined ore (alumina) and metal (aluminium).

Aluminium prices at the London Metal Exchange (LME) jumped nearly 30 per cent last year — from under $1,500 a tonne in April 2016 to over $1,900 per tonne currently. This was aided by unexpectedly good demand from China, (50 per cent consumer of the metal), US infrastructure spending expectations and strong automobile sales.

Demand is expected to be strong, mainly from automotive and aerospace sector, as per research portal Al Circle. This should aid prices to stay above the average production cost of $1,500 to $1,700 per tonne (below which smelters may shutter production). Higher aluminium price bodes well for Nalco as alumina demand would increase.

That said, China’s aluminium output growth (10 per cent) is projected to surpass consumption growth (6 per cent) in 2017. So, prices may be capped at current levels. Also, in India, the demand-supply balance is unfavourable to metal producers due to cheaper imports; this may worsen with planned capacity additions in the next few years.

But a few positives may mitigate this issue. One, the Government is said to be considering imposing minimum import price for certain categories of products. Two, higher local production of aluminium would boost alumina sale — a profitable segment for Nalco. Higher local sale may also mitigate foreign exchange risk from a stronger rupee.

In the nine months ended December 2016, Nalco’s revenue increased 4.3 per cent year-on-year to ₹5,500 crore, helped by both volume and price growth. Alumina sale increased 9 per cent year-on-year to 0.3 million tonnes (mt); aluminium sale grew 2 per cent y-o-y to 99 kilo tonnes. Nalco’s ore production in the 11 months of 2016-17 increased 17 per cent y-o-y to 6.56 mt.

Also, higher share of aluminium boosted revenue and this would likely continue.

Nalco’s profit margin improved, thanks to higher aluminium prices. Average realisation for the metal jumped 22 per cent y-o-y to ₹1.4 lakh per tonne in the December quarter. This helped turn the segment’s operating margin positive. Overall, net profit margin however slipped to 7.3 per cent in the December quarter from 8.6 per cent in the year ago period due to lower other income. The margin may stay in the 7-8 per cent range.

The company did a share buy-back of 64.43 crore shares (25 per cent of outstanding shares) in September 2016 and this will increase the earnings per share.

Nalco’s free cash flow may be impacted due to higher capex plans for its joint ventures (thermal and atomic power; coal tar pitch, caustic soda) and new smelter projects. These investments would, however, increase output and reduce costs over the long run.

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