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Thursday, October 29, 2009

National Aluminium Company Ltd:Future growth outlook and prospects

Scripscan:National Aluminium Company Ltd(NALCO)

Story:In Q1’10, National Aluminium Company Limited's (NALCO's) net salesdeclined by 37.2% yoy to Rs. 9.2 bn and EBITDA fell by 79.1% yoy to Rs. 1.5 bn, mainly on account of a decline in average sale realisations. The average sales realisation for Aluminum (Al) in Q1’10 was USD 1,508 per tonne, as compared to USD 3,040 per tonne in Q1’09, lower by ~50% yoy.The LME Al prices has recovered sharply from last year's lows; however,considering the Al inventory that has piled up at LME and the excess capacity (on account of production cuts across the world), we expect Al prices to remain under pressure in the near-to-medium term. Resumption of idle capacity to put pressure on Al prices: The LME Al prices have rallied sharply since February 2009, driven by the Chinese State Reserve Bureau's (SRB's) restocking and by an expected recovery in the economy. However, we believe that this rally in the LME Al prices is going to be short-lived, especially with LME inventory piling up (LME inventory has soared to ~4.6 mn tonne, ~12% of last year's production), coupled with the increase in supply (as China has restarted 1.28 million tonnes of idlecapacity) will lead to a global-demand supply imbalance and should restrict afurther rise in the Al prices. Accordingly, we believe that the LME Al priceswill remain under pressure, and expect them to be around USD 1,800 per tonne in FY10, as compared to the current price of USD 1,920 per tonne.NALCO has increased its Alumina and Al production capacities by 0.5 mn tonne to 2.1 mn tonnes, and by 0.1 mn tonnes to 0.46 mn tonnes, respectively. With the commissioning of new capacities, coupled with the recovery in demand in the Electrical and Power Equipment segment (which contributes ~70% of Nalco’s revenue), the Automobile and Constructionsegments should result in the volume growth to the company. Consequently, we expect the Al sales volume to increase to 0.37 mn tonne and 0.43 mn tonnes in FY10 and FY11, respectively, as against 0.34 mn tonne in FY09. With the steep fall in LME prices, the average sales realisation of the Company is expected to decline by ~18% yoy in FY10. This decline in sales realisation will drag the EBITDA margins of the Company. However, the fall will be moderated by the decline in power and fuel costs, which is a result of the dip in coal prices. Accordingly, we expect the Company’s EBITDA margin to decline by ~7pts to ~26% in FY10.At the current market price (CMP) of Rs. 363.8, the stock is trading at a forward P/E 28.2x and 19.7x for FY10 and FY11, respectively. Based on DCF valuation, we have arrived at a target price of Rs.279(assuming a 14.8% WACC and a 5% terminal growth rate). Since our target price provides a downside potential of 23% from the CMP, we have maintained our Sell rating for the stock.

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