Margin concerns, higher valuations

Most metal majors, including National Aluminium Company (Nalco), benefited in the quarter-ended March 2011 from firm metal prices on the London Metals Exchange (LME). Average aluminium prices were up seven per cent year-on-year (y-o-y) at $2,524 a tonne during the quarter on the back of strong demand from China. This helped Nalco post a top line growth of 11.5 per cent during the quarter. However, a higher cost of production led by higher coal costs dented its operating performance and thus, Nalco’s net profit declined 18.2 per cent y-o-y. Though the company enjoys a high level of backward integration, analysts have raised concerns over the high cost of production and rising coal costs impacting margins going forward. Most of them are bearish on the stock.

The aluminium realisation for Nalco surged 15.7 per cent y-o-y during the recently concluded quarter, which helped net sales rise 11.5 per cent y-o-y. However, volumes disappointed as the aluminium sales volumes at 118,000 tonnes were flat, and alumina sales volumes fell to 196,000 tonnes due to increased captive consumption — the latter was responsible for the chemical segment revenues declining 15.4 per cent y-o-y to Rs 588 crore during the quarter.

That apart, higher cost, especially that of coal, partly neutralised the gains from the increase in realisation. As the international coal prices remained firm, domestic players like Coal India resorted to price hikes. As a result, Nalco saw its coal costs surge Rs 40 crore during the quarter, reckon analysts.
 

HIGHER COSTS HIT MARGINS
in Rs crore	Q4’ FY11	FY11
Sales	1,788	5,959
Y-o-Y chg (%)	11.5	17.9
PBIDT	551	1,946
Y-o-Y chg (%)	-3.1	31.8
PAT	305	1,069
Y-o-Y chg (%)	-18.2	31.3
Source: Capitaline

A 30 per cent rise in employee costs due to higher wage revision provisions also impacted performance. Thus, the operating profit margin at 25.4 per cent during the quarter was lower as compared to the previous corresponding quarter’s 31 per cent.

The commissioning of the 10th unit of the 120-Mw power plant in the middle of the year helped the electricity segment revenue surge 26 per cent y-o-y to Rs 483 crore during the quarter. However, this also pushed up the depreciation costs by half to Rs 132 crore during the quarter.

The company also bore the brunt of a higher tax rate of 27.1 per cent (FY11) compared to 22.2 per cent in the previous corresponding period. The net profit at Rs 305 crore, thus, declined 18.2 per cent y-o-y in the March 2011 quarter, despite other income increasing by 36.9 per cent y-o-y to Rs 97 crore. For the full year, the net profit was higher due to better performance in the earlier quarters.

Outlook 
At the beginning of the current financial year, the company expanded its alumina refinery capacity from 1.575 million tonnes (mt) to 2.1 mt (which is further being upgraded to 2.28 mt), bauxite capacity to 6.3 Mtpa and aluminium smelter capacity of 4.6 Mtpa.

Though this is positive and the fact that average aluminium prices continue to remain high (they averaged $2,640 a tonne so far in the June 2011 quarter, versus $2,121 in the June 2010 quarter), analysts remain concerned over the high costs and rising coal prices in the near term. Angel Broking analysts observe the supplies from Mahanadi coal fields are not evenly distributed throughout the year. This increases its dependence on external coal, whose firm prices are expected to impact Nalco’s margins going forward.

At Rs 90.50, the stock trades at 18.4 times the 2011-12 earnings estimates and about 10 times the enterprise value to Ebitda, which is higher compared to peers like Hindalco and Sterlite. Thus, most analysts have a sell rating on the stock, with a consensus price target of Rs 80-82.