Taking the heat, comfortably

Unlike its peers who are reeling under pressure because of the high debt in their books, the government-owned aluminium major National Aluminium Company (Nalco) is a little relaxed due to the cash of over ₹5,300 crore in its books. If you do the math at today’s closing, it amounts to 60% of market cap. For the PSU with no immediate capex plan, cash in the books is a big cushion to counter the global down cycle in aluminium demand.

Since January last year, the international aluminium price has corrected by 17% to around $1,500 a tonne currently. Thankfully among industrial metals, aluminium has corrected the least. “Global aluminium production has out-passed consumption by 2.6%, making a surplus of roughly 1.4 million tonnes in 2015. Slowdown in China consumption has resulted in dumping of surplus production in the international market, making a steep fall. Many smelters have been closed and many more are resorting to production cut,” said Tapan Kumar Chand, CMD, Nalco in an earlier statement.

"Non-ferrous metals like copper have seen a higher correction because of its industrial application. Correction in zinc (used in steel making) price is more to do with the down cycle in the steel industry. As for aluminium the expectation is that FY16 onwards prices will recover because of supply cut in the US and China and improvement in demand," says Abhisar Jain, who tracks the sector at Centrum Broking. While capacities are going non-operational in other parts of the world, Nalco has been riding on the advantage of being one of the lowest cost alumina producers in the world.

To put it in perspective, at the current aluminium price, the company’s aluminium business, which accounts for close to 50% of its sales, is incurring a loss. In Q3FY16 on a sales turnover of ₹1,122 crore, that arm incurred an EBIT loss of ₹132.4 crore, which is close to $200 per tonne based on Q3 aluminium production of 96,000 tonnes.

However because of alumina, which is refined and converted from bauxite to produce aluminium, the company has been making a profit. Nalco produces close to 1,900,000 tonnes of alumina annually. In alumina even after the price correction, it makes an EBIT margin of over 27%. The credit goes to its low cost bauxite mines that spew alumina at less than $200 a tonne compared to the current realisation of $274 a tonne. “Nalco operates at fully mechanized bauxite mine in Odisha. This mine is one of the lowest cost mines in the world (cash cost of $9 a tonne) having 310 million tonnes of resources. Because of low cost bauxite, the alumina production cost also stays low for Nalco at sub $200 a tonne. In the global alumina cost curve, this falls in 1st quartile, making it a big beneficiary," says, Goutam Chakraborty, analyst, Emkay Global.

Low-cost edge

All this means, despite the aluminium price hovering at the 2009 level, the company enjoyed a 9% operating margin in third quarter of current financial year despite a 74% decline in operating profit. It also earned an income of ₹124 crore on the cash in the books and that enabled it to post a quarterly profit of close to ₹100 crore.

So far so good, but can it not slide into a loss if the situation worsens? The answer to that lies in how much further can its low-cost alumina and cash can shield it. Based on Q3FY16 production figures, the company is still making a quarterly profit before tax of $320 per tonne of aluminium, which is about 22% of its aluminium realisation of $1,494 per tonne in Q3FY16. The one chink is the armour is the disruption in coal supply that inflates its energy bill and limits its production ability. To achieve full utilisation it requires about 6 million tonne of coal whereas the company has been getting coal in the region of 4-4.5 million tonne. If that is resolved, even if the aluminium price remains at the current level, it can still make a standalone profit in aluminium.

Nalco’s non-availability of coal is easing as a result of higher supplies from Coal India. Further, it recently got back its de-allocated coal mines along with a new coal block having total reserves of 347 million tonne. "Nalco has been running its smelter at 65-70% utilisation over the past couple of years due to limited availability of assured coal. But with the improved supply Nalco has increased its activity in the coal e-auction market. In 3Q it achieved aluminium production of 96,000 tonne, well above the run-rate of 80,000-85,000 tonne in FY15," says Sanjay Jain, analyst, Motilal Oswal Securities.

While energy costs will be lowered with the easing supply, Nalco is also targeting a production of 360,000 – 370, 000 tonnes of aluminium in FY16 as against 327,000 tonne in FY15. Lower cost and higher production, is expected to offset the fall in realisation.  Even if one does not ascribe much value to the loss-making aluminium business, the cash and a ₹4,000 crore valuation on the basis of 1x sales or 4x FY15 EBIT for the profit making alumina business, the valuation of Nalco comes close to ₹9,300 crore. Nalco trades at 4.5x FY17 EV/EBIDTA compared to its peers like Hindalco (7x) and Vedanta (8x). In the light of all this, the stock appears cheap if you thrown in its 5% dividend yield.