India Equity Research Metals & Mining January 15, 2016 Initiating Coverage

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1 National Aluminium Co India Equity Research Metals & Mining January 15, 216 Initiating Coverage Emkay Your success is our success Better positioned in a rough weather! CMP Rs37 Target Price Rs51 ( ) Rating Upside BUY ( ) 37.8 % National Aluminium Company (NALCO) is a PSU with 46 kt smelting facility, 12 MW power plant and 2.23 mtpa alumina refinery supported by 6.8 mtpa bauxite mine. It is one of the lowest cost aluminium producers in the world and better positioned among the peers Low cost alumina business with 36% RoCE (FY15) has been the backbone of the company, as metals business RoCE has been very weak since last five years. With disrupted coal availability and weak prices, NALCO has cut smelter utilization to ~7% NALCO recently got back its earlier de-allocated Utkal E coal block along with Utkal D coal block. This is going to be a big boost for the company s smelter operations going forward, as it will help smoothen coal supply and cost savings of ~Rs 5/ tonne aluminium Strong balance sheet with net cash of Rs 53.3 bn (Rs 21/ share). Focus stays on profitable alumina segment. Valuation looks cheap at 8.7xFY18 PE and 3.xFY18 EV/ EBITDA. Initiate coverage on NALCO with a Buy rating and a target price of Rs 51 Best positioned among domestic peers being net long in alumina NALCO, a Navaratna PSU, is an integrated aluminium producer. It has 6.8 mtpa bauxite mine, 2.23 mtpa alumina refinery and 46 ktpa aluminium smelter along with 12 MW captive power generation capacity. Being strategically located (Odisha) with nearby operations helps it in cost optimizations. The biggest driver for NALCO has been its surplus alumina with RoCE of 36% (FY15). Good quality bauxite from own mine makes it more profitable. Thus, as a step in the right direction, the company is investing more into alumina business, which will ensure better margins in future. We expect aluminium business not to contribute meaningfully unless there is a significant and sustained rise in LME towards US$2/ tonne. Coal availability improved, own mines to aid profitability NALCO had suffered due to poor coal supply by Coal India during FY12- FY14. With higher output and better evacuation from Coal India, NALCO has seen improvement in cost structure. With allocation of Utkal D and E coal blocks by the government, there would be significant cost saving. Coal cost is likely to come down by ~Rs 5/ tonne of aluminium. Sound financials and attractive valuation Unlike its peers, NALCO is debt free, which is a major benefit for cyclical nature of business. NALCO has net cash of Rs 53.3 bn (Rs 21/ share). After meeting future capex requirements also, we see net cash generation due to better profitability. Valuation looks attractive as at the CMP of Rs 37, the stock is trading at 8.7xFY18 EPS and 3.xFY18 EV/ EBITDA. Dividend yield stands at ~4.8%. Valuing it at 5.5xFY18 our fair value for the stock works out to be Rs 51. We initiate our coverage report on NALCO with Buy rating. Financial Snapshot (Consolidated) (Rs mn) FY14 FY15 FY16E FY17E FY18E Net Sales 67,89 73,828 62,682 68,518 73,648 EBITDA 9,869 17,86 9,72 11,767 13,346 EBITDA Margin (%) APAT 7,444 11,76 7,645 9,617 1,912 EPS (Rs) EPS (% chg) (35.) ROE (%) P/E (x) EV/EBITDA (x) P/BV (x) Change in Estimates EPS Chg FY16E/FY17E (%) NA Target Price change (%) NA Previous Reco NOT RATED Emkay vs Consensus EPS Estimates FY16E FY17E Emkay Consensus NA NA Mean Consensus TP Rs 41 Stock Details Bloomberg Code NACL IN Face Value (Rs) 5 Shares outstanding (mn) 2, Week H/L 53 / 28 M Cap (Rs bn/usd bn) 88 / 1.3 Daily Avg Volume (nos.) 1,373,75 Daily Avg Turnover (US$ mn).8 Shareholding Pattern Sep '15 Promoters 8.9% FIIs 2.8% DIIs 9.5% Public and Others 6.7% Price Performance (%) 1M 3M 6M 12M Absolute (18) (15) (12) (27) Rel. to Nifty (3) (4) 3 (15) Relative price chart 6 Rs % Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 National Aluminium (LHS) Rel to Nifty (RHS) Source: Bloomberg Goutam Chakraborty goutam.chakraborty@emkayglobal.com Deepankar Kohli deepankar.kohli@emkayglobal.com Emkay Research is also available on Bloomberg EMKAY<GO>, Reuters and DOWJONES. Emkay Global Financial Services Ltd.

2 Investment arguments NALCO s - a) superior position amongst peers in terms of cost advantage, better integration and strategic location, b) profitable alumina segment, c) strong balance sheet with net cash and d) attractive valuations makes it a good investment idea. In all these parameters, NALCO stands superior to its domestic peers. Best positioned amongst domestic peers NALCO, a Navratna PSU, has a 46 ktpa aluminium smelter capacity, backed by a 2.23 mtpa alumina refinery supported by a captive bauxite mine (6.8 mtpa) and 12 MW captive power. NALCO is best positioned amongst its peers in terms of integration, strategic location, cost advantage and balance sheet strength. The company has close to 16% domestic share in Aluminium segment, with higher capacity utilization, it is likely to grow that share. Moreover, NALCO is net long in alumina, which has been its biggest advantage. Exhibit 1: NALCO: Capacity of Operating Units Unit Bauxite Mines Alumina Refinery Aluminium Smelter Captive Power Plant Wind Power Plant - I Wind Power Plant - II Rooftop Solar Power System Capacity 6825 Mt 2275 Mt 46 Mt 12 MW 5.4 MW 47.6 MW 26 KWp Exhibit 2: Indian Aluminium Capacity & Production (KT) Company Installed Capacity Production FY15 % Utilization BALCO % Vedanta Ltd % Vedanta Ltd SEZ % NALCO % HINDALCO % Total Primary Production % Source: Industry, Emkay Research Better integration helps in smooth process NALCO is a backward integrated producer of aluminium. Good quality bauxite helps in low cost alumina, which in turn, helps in aluminium production. The 12 MW coal based captive power plant helps the aluminium smelting. So far, the company has been primarily sourcing coal from Coal India through linkage. However, with the company being allotted two coal mines, Utkal- D and E, we believe, going forward NALCO will be further well integrated. Aluminium being power intensive industry, coal integration and captive power is vital. NALCO has also ventured into solar and wind power projects. While NALCO has a total wind power capacity of 98 MW, it has roof top solar power capacity of 26 KW. For logistics, NALCO uses its own locomotives and wagons and it has its own mechanized storage and ship building facilities for exporting calcined alumina and importing caustic soda. It has aluminium storage capacity of 3x25, tonnes. Strategic location ensures efficient movement of goods NALCO s mine, refinery and smelters are located nearby making it economically feasible. A 18 TPH, single flight, multi-curve cable belt conveyor connects the bauxite mines to the refinery at Damanjodi, which is just 14.6 km away from the mine. This helps in cutting down costs on account of freight and also fuel. Strategic location of the refinery near port makes it cost effective for the company to export alumina. Emkay Research January 15, 216 2

3 Exhibit 3: Proximity to ports help in better logistics Cost advantage NALCO operates at fully mechanized Panchpatmali Hills bauxite mine at Koraput district of Odisha. This mine is one of the lowest cost mines in the world with cash cost of production of around US$9/ tonne only. Total resources stand at 31 mt. Backed by low cost bauxite, the alumina production cost also stays low for NALCO at sub US$2/ tn. In the global alumina cost curve, this falls in 1 st quartile, making NALCO a big beneficiary. Along with its efficiency related cost advantages, NALCO also benefits from better integration and strategic location, which helps in reducing logistics costs to a great extent. Alumina- the key driver Unlike its domestic peers, NALCO s business model is mainly dependent on alumina rather than aluminium. This has been supportive as demand- supply dynamics in alumina is better than that in case of the metal. In the long run, this is also true in the context of capacity expansion in aluminium metal going around the world and singular use of this intermediary commodity. The pricing scenario has been weak in recent months. Alumina spot prices fell steadily during CY215, due to decreasing demand in China, weak aluminium prices and supply growth. As per some global commodity research houses, spot alumina prices are likely to stay subdued in the near term due to closure of smelters. However, the 215 average was forecast at US$339/ tonne, higher than 214 level of US$331/ tonne. Recently, in past two months, prices fell sharper than expectations and the average stands at US$31/ tonne for CY15. NALCO s average realizations are better than this, as for CY14, NALCO s average alumina realizations were US$336/ tonne. In YTDCY15 the same has been US$319/ tonne. We expect the alumina realizations to remain weak in H1CY16 and should improve in H2CY16. In fact, alumina prices in medium term are expected to increase as small-scale operations in China are estimated to expand and is likely to help removing supply from the market. According to Alcoa s latest presentation Alumina is set to be in deficit in CY16 by 2.8 mt. Emkay Research January 15, 216 3

4 Exhibit 4: Alumina is likely to be in deficit by 2.8 mt in CY16: Alcoa 216 Alumina Balance China Rest of World Production at Beginning Run Rate 56,87 56,9 Production to be Added/Restarted 3,993 1,61 Production to be Closed/Curtailed -3,615-2,85 Imports/(Exports) Full Year 4,4-4,4 Total Production 61,585 52,25 Demand -62,85-53,56 Net Balance -1,22-1,535 Source: Alcoa presentations, Emkay Research World alumina production is forecast to continue to grow in 215 supported by new additions to capacity. However in long run, growing aluminium consumption and production will support the fundamentals. Some other forecast too suggest that in the longer term, alumina will remain in deficit. The companies which are expected to be a part of demand supply chain for Alumina in coming years are mentioned in below charts. Exhibit 5: Share of world third party Alumina Demand (Mt) Dubal Alba Century Vedanta CPI Yunnan Aluminum Zengshi Xinheng group Aluar EMAL % of WTD Source: Industry, Emkay Research 4% 3% 2% 1% % Exhibit 6: Share of world third party Alumina Supply (Mt) % 6% 4% 2% % Alcoa/AWAC Chalco Jinjiang Group Xinfa Group BHP Billiton Rio Tinto Alcan Weiqiao Hydro Nalco ENRC % of WTS Source: Industry, Emkay Research Emkay Research January 15, 216 4

5 NALCO has already contracted its 7% alumina volume at 17.5% of Aluminium LME for CY16 Price movement in alumina as against aluminium has been more steady in recent years. Alumina prices, as a percentage of aluminium, has been rising. As per recent data alumina prices have been hovering at around 14% of the LME, which is lower than the long term average of 17%. During the month of May, 215, alumina prices reached 2% of the LME aluminium. Though, very recently spot alumina prices have drifted down, we believe, it will continue to outperform aluminium prices. NALCO meanwhile, has already contracted 7% of its alumina at 17.5% of LME for CY16, which should help the company in reducing the volatility. Any improvement in LME during the course of time would thus, result into double benefit for the company. Exhibit 7: Alumina as a percentage of Aluminium LME ($/ tonne) 22% 2% 18% 16% 14% 12% 1% Nov-11 Feb-12 Apr-12 Jun-12 Sep-12 Nov-12 Jan-13 Apr-13 Jun-13 Aug-13 Oct-13 Jan-14 Mar-14 May-14 Aug-14 Oct-14 Dec-14 Mar-15 May-15 Jul-15 Sep-15 Dec-15 NALCO s market is focused towards the less volatile Middle East After meeting its captive requirement, NALCO sells its surplus alumina through auction. Since last 1 years, on an average, exports have been contributing more than 95% of alumina sales. NALCO predominantly supplies its alumina to the Middle East markets, where it gets better premium over the South East Asian markets including China due to lesser competition and freight differential. We understand the demand environment is also better in Middle East compared to other regions. In that sense, it remains helpful for NALCO. Exhibit 8: NALCO s alumina Production trend e 217e 218e Production (kt) Exhibit 9: Exports as percentage of Nalco s alumina sales volume 1% 99% 98% 97% 96% 95% 94% 93% 92% 91% 9% FY6 FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e Emkay Research January 15, 216 5

6 Superior margins in alumina segment to continue This is important as it is the alumina segment, which has been making sound profits offsetting the low profitability/ losses made in smelting business. The segmental EBIT performance can prove it. During the last eight quarters, the average EBIT margin of the alumina segment has been 26%. We expect the company to maintain better margins in alumina segment going forward. Smelter margins improved during FY15 due to better coal availability. Sustaining positive EBIT margins in aluminium will help the company to see much better performance in forthcoming quarters. At the EBITDA level however, we don t expect any meaningful contribution by aluminium segment in next couple of years, unless there is significant jump in LME. Exhibit 1: EBIT Margin (%) Alumina vs Aluminium 8% 6% 4% 2% % -2% FY5 FY6 FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 Alumina Margin Aluminium Margin Along with superior margins, contribution of alumina segment in total EBIT has been much better for NALCO. In last 1 years, the average contribution from alumina segment has been 48%. Electricity and aluminium contributed the rest. During the last five years, contribution of alumina segment to the total EBIT has been higher at 6%. In 211, EBIT contribution by alumina fell towards 16%, however, it rose gradually since then to reach to ~85% in FY13 and FY14 before falling below 6% in FY15. With capacity addition in alumina segment, we expect EBIT contribution by alumina segment to continue to increase in future. Exhibit 11: % EBIT from Alumina for NALCO 1% 9% 8% 7% 6% 5% 4% 3% 2% FY5 FY6 FY7 FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 Investing in refinery- a step in right direction In this regard, it is important to mention that the next major capex spending has been targeted at commissioning of a new 1 mtpa alumina refinery for Rs 56 bn. The company has been waiting for commencement of work on this project pending clearance of Pottangi bauxite mine. Recently, the company has got an in-principle go ahead for the Pottangi bauxite mine from the state government of Odisha and is waiting for the formal allocation of the mine. We understand that some procedures are being completed in this regard. This mine with ~75 mt bauxite reserve will service the upcoming refinery. This is, we believe, a step in the right direction, as alumina is the most profitable business, where the company plans to expand its capacity. Smelter utilizations kept lower to counter higher costs NALCO has a linkage of 4.6 mtpa of coal from Coal India. However, the company suffered losses during FY12 to FY14 due to high coal costs arising from less than required supply from Coal India. For 1% utilization of its smelter, it requires 6 mtpa coal. With lesser supply from Coal India, NALCO had to rely on high cost imports, which resulted in a fall in its profitability. The company however, took a logical step to cut down the utilization level of the smelter to the extent it can be supported by the linkage coal availability. In FY15 and H1FY16, with improvement in Emkay Research January 15, 216 6

7 coal availability through linkage and also e-auction, the company also has been improving on its smelter utilizations. With the hope that coal availability through e-auction will be maintained, NALCO is planning to achieve aluminium metal production of kt in FY16 instead of the earlier envisaged 32 kt. According to the management, even with a further US$1/ tn fall in aluminium LME, the company will continue to produce at the targeted rate provided coal is available through linkage and e-auction. This, we believe, is a good strategy of the company to control costs. Exhibit 12: NALCO s aluminium Production and Utilization % 1% 8% 6% 4% 2% % e 217e 218e Production (kt) Utilization (%) Coal cost advantage due in next couple of years- a major trigger NALCO was allotted Utkal- E coal mine in 24. The company had started basic development work also and spent Rs 1.3 bn on land acquisition before it was de-allocated by the government, following a Supreme Court order regarding discrepancy in coal block allocation issue. Recently, the company was re-allocated the same mine along with another block, Utkal- D. This is should be seen as a big positive for NALCO. As per available data, together, these two blocks have 347mt (153 mt from Block D and 194 mt from Block E) of coal reserve. According to the management, substantial work was done in Utkal- D by the previous allottee and thus, NALCO will develop this block first. This will bring down the coal cost substantially ensuring smooth supply at the same time. Also, as per the new policy, the PSUs can continue with the linkages even if they are allotted mines. Considering the volume growth in Coal India, we are confident that NALCO should get 9-95% of the linkage quota of 4.6 mtpa. In case of own mine, NALCO is likely to target ~2 mtpa coal from Utkal- D initially. This will result in substantial cost savings for the company. Also, the company will able to increase the utilization of the smelter and thereby improved performance. Currently, on an average basis, linkage coal costs Rs 16-18/ tonne while, e- auction prices have been hovering at around Rs 3-32/ tn. Against these rates, we believe, landed costs of coal from own mine not to cross Rs 1/ tonne. Since, this will eventually replace e-auction coal, there should be a saving of Rs 2/ tonne of coal for that much quantity. For the entire coal usage, this is likely to bring down the coal costs by Rs 5/ tonne of aluminium. This itself can improve EBITDA by ~15%. At present we are not factoring this into our estimates, as the official allotment of the mines are yet to be done and logistics issues to transport the coal from the mine to the plant need to get fixed. Exhibit 13: Average Coal Cost (Rs/ tonne) Emkay Research January 15, 216 7

8 Strong balance sheet with net cash makes NALCO stand out Unlike its peers, the biggest advantage for NALCO lies in its balance sheet strength. While its peers are struggling with huge debt, NALCO has a net cash of Rs 53.3 bn. In fact at the current CMP of Rs 37/ share, cash contributes more than 5% of the market capitalization. This gives better room for the required capex spending by the company. Exhibit 14: Cash per share (Rs mn) FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e Exhibit 15: Net Debt for NALCO and its peers for H1FY16 (Rs bn) NALCO Hindalco (Standalone) Vedanta (Except Cairn, HZL, Zinc Int. and Talwandi Sabo) Cash accumulation is likely to continue As per the management, the FY16 capex is likely to be Rs bn. Similar amount is expected to be spent in FY17 also. Majority of the capex would be spent on the 1 MW wind power plant. We expect some capex spending to start on Damanjodi refinery also. Most of the other major capex viz. GMDC, project, NPCL, Sundergarh projects etc are not much in focus due to various issues. At present, NALCO is free cash flow positive and is likely to generate healthy cash flows even after paying dividend. Emkay Research January 15, 216 8

9 Exhibit 16: Capex Project Description Investment Current status Likely completion Wind Power To add 1 MW, to the existing Rs 7 bn Company has finalized location, By FY17 capacity of 99 MW talking to contractors. Government of India had reserved Pottangi mine for NALCO in April-7 1 mtpa alumina refinery To expand 5th stream which is Rs 56 bn Government of Odisha has given If mining lease in granted in stream at Damanjodi, linked to the 3 mtpa Pottangi mine approval, lease is awaited FY16, alumina refinery could Odisha be commissioned by FY18 Utkal-D& E Coal Mine, Development of Utkal- E mine which Rs 1.3 bn spent NALCO has been re-allotted this Utkal- D mine likely to be Odisha has 68 mt of reserves out of total mine taken up first (FY18) and budget of Rs 4.8 then Utkal- E bn Caustic Soda Project, To set up 27 ktpa Caustic Soda Rs 7.2 bn Detailed project report including a Beyond FY18 Dahej, Gujarat plant in Gujarat in a JV with GACL captive power plant is being finalized Alumina refinery, Gujarat To set up 1 mtpa greenfield refinery in Gujarat in a JV with GMDC Rs 64 bn Discussions with GMDC are on Beyond FY19 Kakrapar Units 3 & 4 To set up 2 X 7 MW Nuclear Rs 135 bn, Running behind schedule; Work yet Beyond FY2 power plant in a JV with NPCIL NALCO is having to begin 26% stake in JV Sundergarh smelter + To set up 5 ktpa smelter and Rs 2 bn Will go ahead only if a separate coal Beyond FY2 Captive Power Plant, 1,26 MW captive power plant as block is allotted for CPP Odisha Greenfield project Strong dividend yield makes it more attractive NALCO has been consistently increasing its dividend per share since FY11. From Re 1/ share in FY11, it has increased its dividend to Rs 1.75 per share in FY15. We expect the company to continue with its dividend policy. At CMP this translates to a dividend yield of 4.8%, which looks attractive on top of its growth prospect. Exhibit 17: Dividend Yield and DPS FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e 8% 7% 6% 5% 4% 3% 2% 1% % DPS Dividend Yield Emkay Research January 15, 216 9

10 Concerns Weak aluminium and alumina prices The biggest concern for the company and risk to our estimates would be aluminium and alumina prices. Aluminum prices have been hovering near US$15/ tonne for sometime now, while physical premium also has fallen sharply over past few months. This has been putting pressure on all the smelters including NALCO. Alumina prices, so far have been stable, however, recently fell sharply and if the downtrend sustains, it could be negative for the company. Lower coal supply in the domestic market NALCO had already suffered due to lower than required coal supply by Coal India earlier. As the company had to rely on imports, it put pressure on the margins significantly. At present, the domestic supply has improved and the company has stopped imports too. However, any short supply of coal by Coal India will be a major concern for the company. Delay in coal mining projects We understand that NALCO has not yet got formal allocation of the Utkal D & E coal mines. Once it gets them, the challenge will be to start developing those mines. In Utkal- E block full land acquisition is pending and it might take time. Also, logistics can be a major challenge in this regard. Employee costs Being a PSU, employee costs are very high for NALCO and upcoming wage revision in this regard would be very important to look at. Significantly higher settlement will raise the costs and thus will weigh on the margins and profitability. Cheaper imports from China & Middle East threat for domestic industry Cheaper import of aluminium from China and Middle East have been a worry for the domestic producers including NALCO. Share of imports into the domestic consumption has increased from 4% in 211 to 56% in 215. Consistent increase in cheap imports will be a major issue for the aluminium producers. Poor grade of bauxite at new mine NALCO s currently operating mine Panchpatmali has very good quality of bauxite. In Pottangi mine however, the quality of bauxite may not be very good requiring for higher per unit consumption and rise in cost structure from the current level. Overhang of OFS Presently, the government of India holds 8% in the stock. So, there can still be 5% sale by the government most likely through OFS. Given the experience of the past OFS in NALCO and other PSUs, this can be an overhang on the stock. Emkay Research January 15, 216 1

11 Financials Revenue likely to be back on track in FY18 Sales volumes for Alumina rose by 42% from FY8 to FY15 while volume for Aluminium rose by 25% for same period. As a result, the topline of the company grew at a CAGR of 5.7% during this period. Realizations also stood firm at US$241/ tonne in FY15, thanks to stronger physical premium. Going forward as we see gradual growth in volume and stabilization in Aluminium LME and Alumina prices, we expect revenue of the company to gradually improve FY17 onwards with better volume and stabilization in the realizations. Exhibit 18: After falling in FY16, revenue is likely to gradual improvement 8, 7, 6, 5, 4, 3, 2, 1, - FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e EBITDA Margin to remain stable Revenue (Rs mn) NALCO has been amongst the lowest cost producers of aluminium in the world, resulting into better EBITDA margins. NALCO had been reporting margins of above 45% till FY11. After this the margins fell because of significant increase in that the coal cost as the company had to import coal, as Coal India failed to supply the required quantity. Further, fall in realizations due to decline in LME also weighed. Since 212, it has been maintaining EBITDA margin of 2% and we believe, after a slight decline in FY16, it will continue to improve gradually. In case of segmental performance, outperformance of alumina segment over aluminium is likely to continue. Exhibit 19: EBITDA (Rs mn) and EBITDA Margin (%) FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e 7% 6% 5% 4% 3% 2% 1% % EBITDA EBITDA Margin Exhibit 2: NALCO EBIT/ tonne diversification (Rs) 4, 3, 2, 1, - (1,) Alumina EBIT/ tn Aluminium EBIT/ tn Emkay Research January 15,

12 Profitability to rise further On the back of better topline growth and better margin, we believe the company should see better growth in PAT as well. From FY9 to FY15, PAT grew by CAGR of 1%. After falling in FY16, we expect the PAT to improve gradually. Expected better PAT growth can be attributed to low fixed costs and improved margins. Other income also is likely to grow with better cash generation. Exhibit 21: Net profit (Rs mn) and NPM trend 25, 5% 2, 4% 15, 3% 1, 2% 5, 1% % e 217e 218e APAT APAT Margin (%) ROCE and ROE are likely to improve With improvement in profitability, return ratios are also likely to improve further. For FY15 the ROCE was recorded at 15%, which after declining in FY16e is likely to rise back to 1% level again in FY18e. ROE is also expected to rise to 8% in FY18e and be at par with current levels of 9%. So the company is efficiently utilizing its capital employed with profitable returns going forward. Exhibit 22: ROCE (%) Exhibit 23: ROE (%) 25% 16% 2% 14% 12% 15% 1% 1% 8% 6% 5% 4% 2% % % FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e FY8 FY9 FY1 FY11 FY12 FY13 FY14 FY15 FY16e FY17e FY18e Emkay Research January 15,

13 Assumptions We have taken following assumptions for our estimates. We believe, commodity prices and currencies will remain volatile and thus, subject to change. For aluminium prices, we expect some gradual improvement going forward. Exhibit 24: Assumptions for commodity and FX Assumptions e 217e 218e Aluminium LME (US$/ tonne) Alumina LME (US$/ tonne) Aluminium Sales ( tonne) Alumina Sales ( tonne) INR: US$ Source: Emkay Research Sensitivity Both aluminium and alumina prices along with coal costs are critical for NALCO s operational performance. The following exhibits show the sensitivity to prices of aluminium, alumina and coal on the EBITDA, EPS and target price. Interestingly, impacts are similar in all three cases. As per the estimates, 1% change in aluminium LME will change EBITDA by 3.3%, 1% change in alumina prices will affect EBITDA by 2.1% and 1% change in coal costs will change the EBITDA by.9%. Exhibit 25: Sensitivity to change in Aluminium prices (FY18) Aluminium LME ($/tn) % Change EBITDA (Rs mn) EPS (Rs) TP (Rs) % % Base Case = 1775 % % % Source: Emkay Research Exhibit 26: Sensitivity to change in Alumina prices (FY18) Alumina LME ($/tn) % Change EBITDA (Rs mn) EPS (Rs) TP (Rs) 27-1% % Base Case = 3 % % % Source: Emkay Research Exhibit 27: Sensitivity to change in Coal prices (FY18) Avg Coal Cost (Rs/tn) % Change EBITDA (Rs mn) EPS (Rs) TP (Rs) % % Base Case = 173 % % % Source: Emkay Research Emkay Research January 15,

14 Valuation- attractive with div yield of 4.8% Like many other metals stocks, NALCO has suffered a lot along with the sharp fall in metals prices. Some company specific issues such as lack of coal availability also weighed on the performance earlier. With better strategy to cut smelter utilizations and focusing more on alumina segment along with subsequent improvement in coal supply by Coal India, the company could overcome most of its challenges. Optimum coal supply by Coal India, both through linkages and e- auction, is going to be helpful for NALCO going forward. The company will be further benefitted as and when it starts its own coal mining. On top of this, in near to medium term, any improvement in aluminium and alumina prices would be a big positive for the company s operational performance. AT CMP of Rs 37, the stock discounts its FY16E, FY17E and FY18E earnings by 12.5x, 9.9x and 8.7x respectively. Also the stock is available at 5.1x FY16E EV/ EBITDA, 3.7x FY17E EV/ EBITDA and 3.x FY18E EV/ EBITDA. This suggests that the stock is quite attractively placed in terms of valuation and provides room for substantial upside. At the CMP, the dividend yield of 4.8% makes it even more attractive. We value the stock at 5.5xFY18 EV/ EBITDA to arrive at a fair value of Rs 51. We initiate our coverage with a Buy rating. Any improvement in Aluminium LME will provide further upside to our valuation. Exhibit 28: Valuation Table Rs (mn) FY18E EBITDA EV/EBITDA (x) 5.5 EV 7343 Net Debt Market Cap No. of Shares 2577 Fair Value (Rs) 51 Source: Emkay Research Exhibit 29: P/E Band Exhibit 3: EV/EBITDA Band Jan-7 Aug-7 Mar-8 Oct-8 May-9 Dec-9 Jul-1 Feb-11 Sep-11 Apr-12 Oct-12 May-13 Dec-13 Jul-14 Feb-15 Sep-15 12x 1x 8x 6x 4x Jan-7 Aug-7 Mar-8 Sep-8 Apr-9 Nov-9 May-1 Dec-1 Jun-11 Jan-12 Aug-12 Feb-13 Sep-13 Mar-14 Oct-14 May-15 Nov-15 8x 9x 7x 6x 5x 4x 3x 2x Source: Emkay Research, Company Source: Emkay Research, Company Peer comparison NALCO stands out amongst its global peers as it is trading at low multiples. Exhibit 31: Peer Valuation Mcap PER P/BV EV/EBITDA Company (USD Bn) FY16E FY17E FY16E FY17E FY16E FY17E Alcoa x 12.8x.8x.7x 7.1x 6.x Chalco 8.5 NA NA.8x.9x 15.1x 16.1x Hydro x 15.6x.8x.8x 4.4x 5.6x Rusal x 5.4x 1.6x 1.3x 6.1x 9.6x Hindalco x 7.9x.4x.4x 7.9x 6.7x Alumina Ltd x 27.x.9x.9x 32.8x 69.2x NALCO x 9.9x.7x.7x 5.1x 3.7x Al Bahrain x NA.5x.6x 3.4x 9.5x Source: Emkay Research, Bloomberg Emkay Research January 15,

15 Annexure 1: Company background NALCO National Aluminium Company Limited (NALCO) is a Navratna CPSE under Ministry of Mines, Govt. of India. It was established on 7th January, 1981, with its registered office at Bhubaneswar. The Company has integrated and diversified operations in mining, metal and power with sales turnover of Rs 724 crore in financial year Presently, Government of India holds 8.93% equity of NALCO. The company has a lakh TPA Bauxite Mine & lakh TPA Alumina Refinery located at Damanjodi in Koraput dist. of Odisha, and 4.6 lakh TPA Aluminium Smelter & 12 MW Captive Power Plant located at Angul, Odisha. As per diversification plan, NALCO has ventured into renewable energy sectors. The Company has successfully commissioned two wind power plants. A 5.4 MW wind power plant at Gandikota, Andhra Pradesh and another of 47.6 MW wind power plant at Jaisalmer, Rajasthan are operational since December, 212 and January, 214 respectively. 26 KWp Rooftop Solar Power System has been made operational at Office and Township, Bhubaneswar during FY NALCO has bulk shipment facilities at Vizag port for export of Alumina/Aluminium and import of caustic soda and also utilises facilities of Kolkata and Paradeep ports. The company has its regional marketing offices in Delhi, Kolkata, Mumbai & Chennai its branch offices at Bangalore, Paradeep, Ahmedabad and its 11 stockyards at various locations in the Country. NALCO is the first Company in Aluminium sector in the Country to venture into International market in a big way with London Metal Exchange (LME) registration since May, All the manufacturing units and the port facility of the Company. In its efforts for capacity addition and expansion, NALCO has extensive plans for brown field and green field expansion projects, which include 1 MTPA Alumina Refinery in Gujarat in JV with Gujarat Mineral Development Corporation (GMDC) (Greenfield), 5th Stream of 1 MTPA capacity in existing Alumina Refinery at Damanjodi (Brownfield),.5 MTPA Aluminium Smelter and 15 MW Power Complex in Odisha (Greenfield),.5 MTPA Aluminium Smelter abroad and development of bauxite mines at Gudem and KR Konda in Andhra Pradesh and Pottangi in Odisha etc. The Company has plans to set up a 2 lakh TPA caustic soda plant in JV with Gujarat Alkalies & Chemicals Limited (GACL) and 55, TPA Aluminium Conductor plant in JV with Power Grid Corporation of India Limited (PGCIL). The Company has plans to set up a 14MW wind power plant at mined out area of Damanjodi and another 1MW wind power plant at any suitable location in the Country. The company has formed a JV Company with Nuclear Power Corporation of India Limited (NPCIL) for establishing 2X7 MW Nuclear Power Plants at an estimated investment of Rs. 11,459 crore at Kakrapara in Gujarat. For development of downstream ancillary industries, a JV Company has been formed with IDCO, Odisha for Angul Aluminium Park. The company is involved in playing a significant role in the socio-economic development of the areas where it operates. Rehabilitation of displaced families, employment, income generation & health care for local people, development of infrastructure, care for environment and various humanitarian goodwill missions have earned NALCO a place of pride in the corporate world. With the setting up of NALCO Foundation and doubling of CSR budget to 2% of the net profit, the company is well-poised to augment its activities on social responsibilities significantly. In order to promote education amongst tribal children, NALCO has sponsored more than 655 students in reputed educational institutes in Odisha by way of bearing all their expenses on studies including lodging and boarding etc. Bauxite Mines On Panchpatmali hills of Koraput district in Orissa, a fully mechanized opencast mine is in operation since November, 1985, serving feedstock to Alumina Refinery at Damanjodi located on the foothills. Present capacity of Mines is lakh TPA. Panchpatmali plateau stands at elevation of 1154 m to 1366 m above mean sea level. Bauxite occurs over the full length of the Panchpatmali plateau, which spans over 18 kms. Emkay Research January 15,

16 The salient features: Area of deposit - 16 sq. KM Resource - 31 million tonnes Ore quality - Alumina 45%, Silica 3% Mineralogy - Over 9% gibbsitic Over burden - 3 meters (average) Ore thickness - 14 meters (average) Transport KM long, single flight, multi-curve cable belt conveyor of 18 TPH capacity Alumina Refinery The Alumina Refinery is located at Damanjodi, Odisha, approximately 14 KM from the bauxite mine at Panchpatmali. The mined-out bauxite is transported from captive mine to refinery by a 14.6 KM long single-light multi-curve 18 tonnes per hour (TPH) capacity cable belt conveyor. The alumina produced is transported to aluminium smelter at Angul (Odisha) and to Vizag (Andhra Pradesh) port by rail. The present capacity of Alumina Refinery is lakh TPA. Alumina produced is used to meet Company's requirements for production of primary aluminium at smelter. The surplus alumina is sold to third parties in the export markets. The salient features: Atmospheric pressure digestion process Pre-desilication and inter-stage cooling for higher productivity Energy efficient fluidised bed calciners Co-generation of 4x18.5 MW power by use of back pressure turbine in steam generation plant Aluminium Smelter The present capacity of smelter is 4.6 lakh TPA. Alumina is converted into primary aluminium through a smelting process by using electrolytic reduction. From the pot-line, the molten aluminium is routed to either the casting units, where the aluminium can be cast into ingots, sow ingots, tee ingots, billets, wire rods, cast strips and alloy ingots, or to RPU where the molten aluminium is rolled into various cold-rolled products or cast into aluminium strips. Aluminium products are sold in the domestic market and also exported through Kolkata, Paradeep & Vizag ports. NALCO acquired and subsequent merged International Aluminium Products Limited (IAPL), the 5, tpa export-oriented Rolled Products Unit with NALCO. The RPU is integrated with the Smelter Plant at Angul for production of aluminium cold rolled sheets and coils from continuous caster route based on the advanced technology of FATA Hunter, Italy. It has also started production of another variety of rolled product named as chequered sheet with thickness ranging from.6mm to 3.mm. The salient features: 18 KA cell technology Micro-processor based pot regulation system Fume treatment plant with dry-scrubbing system for pollution control and fluoride salt recovery Integrated facility for manufacturing carbon anodes, bus bars, anode stems etc. Hyper Dense Phase System (HDPS) for alumina feeding. 4 x 35 Tonne and 4 x 45 Tonne furnaces and 2 x 15 TPH and 2 x 2 TPH ingot casting machines 4 x 45 Tonne furnaces and 2 x 9.5 TPH wire rod mills 2 x 45 Tonne furnaces and 6/42 per drop billet casting machine 2 x 1.5 Tonne induction furnace with a 4 TPH alloy ingot casting machine 26, TPA strip casting machines 2 x 45 Tonne furnaces and 9 TPH tee ingot casting machine 2 x 45 Tonne furnaces and 2 TPH sow ingot casting facility are being installed Emkay Research January 15,

17 Annexure 2: Aluminium industry Domestic demand to gain momentum from Power, automobile and consumer durable sectors to drive long-term demand During 29-1 to , aluminium demand recorded a 4.8% CAGR, in-line with the growth recorded by the power and automobile sectors. In , demand rose 7% to 1.9 million tonnes, as demand from the key end-user sectors automobiles, power and consumer durables (together accounting for 65-7% of domestic demand) improved 7%. Aluminium demand is likely to rise 7-8% in , as demand from key end-user sectors increase. Over to 219-2, demand will record 8-9% CAGR, with demand in volume terms pegged at about 3 million tonnes. The moderate growth rate would be supported by rising demand from the automobile, power and consumer durable sectors. Exhibit 32: India: Sector-wise break up of Aluminium consumption 6% 3% Transport 4% Construction 32% Packaging Exhibit 33: World: Sector-wise break up of Aluminium consumption 6% Transport 9% Construction 5% 27% Packaging 38% 9% Electrical Consumer Durable Machinery & Equipment 13% 25% Electrical Consumer Durable Machinery & Equipment 8% Others 15% Others Source: Industry, Emkay Research Source: Industry, Emkay Research Exhibit 34: Indian market moving towards surplus supply Producer (kt) FY14 FY15 FY16 (E) FY17 (E) Consumption (Metal+Scrap) Consumption (Metal excl. scrap) Metal Production Surplus (net of scrap imports) Source: Industry, Emkay Research US and India positive; EU and China to play spoilsport Global aluminium demand, which increased 6% y-o-y to million tonnes in 214, is expected to rise by a slower 4-5% in 215. The CAGR is projected to remain at 4-5% levels over 215 to 217. Between 215 and 219 as well, demand is forecasted to clock 4-5% CAGR vis-a-vis 8.2% CAGR during 29 to 214. Exhibit 35: Per capita consumption of Aluminium (Kg/ person) India China World Source: Industry, Emkay Research Exhibit 36: Share of Primary producers in domestic consumption 1% 8% 6% 4% 2% % FY11 FY12 FY13 FY14 FY15 Primary Producer s Domestic Sale Import s Share in India Source: Industry, Emkay Research Emkay Research January 15,

18 Exhibit 37: Aluminium Demand Supply Scenario 216 Aluminum Balance China Rest of World Production at Beginning Run Rate 31,53 26,968 Production to be Added/Restarted 3,4 1,1 Production to be Closed/Curtailed -2, Total Supply 32,33 27,212 Demand -31,217-29,254 Net Balance 816-2,42 Source: Alcoa presentations, Emkay Research The tepid growth is because of a slowdown in investments in the various industries in the aftermath of the European debt crisis. Also, usage of the metal in China, the largest global consumer, will decrease as moderate growth in the country's real estate investments will translate into lower demand for the metal from the construction sector. Demand in Japan will be sluggish on account of lower demand from the automobile and construction sectors. While the US has shown relatively better growth, the country accounts for less than 14% of primary aluminium consumption and less than 5% of the incremental global demand. Exhibit 38: China produces more than 5% in Al as well; Production breakup for Aluminium (Mt) Jan'12 Mar'12 May'12 Jul'12 Sep'12 Nov'12 Jan'13 Mar'13 May'13 Jul'13 Sep'13 Nov'13 Jan'14 Mar'14 May'14 Jul'14 Sep'14 Nov'14 Jan'15 Mar'15 May'15 Jul'15 Sep'15 Africa North America South America Asia (ex China) West Europe East & Central Europe Oceania GCC China ROW Source: Industry, Emkay Research Exhibit 39: Aluminium physical premium (USD/ tonne) Aug/12 Oct/12 Dec/12 Feb/13 Apr/13 Jun/13 Aug/13 Oct/13 Dec/13 Feb/14 Apr/14 Jun/14 Aug/14 Oct/14 Dec/14 Feb/15 Apr/15 Jun/15 Aug/15 Oct/15 Dec/15 US Midwest Alum. Prem. Source: Bloomberg, Emkay Research MB Japan Alum. Ingot Prem. Emkay Research January 15,

19 Annexure 3: Alumina industry The Chinese angle Like other commodities, alumina too is dependent to a great extent on China, where less than anticipated consumption has impacted the pricing scenario in CY15. As per the estimates, China is adding up capacities in Aluminium and that will be the key driver for growth in Alumina demand going forward. Better global prices for Alumina will impact NALCO s realization directly which is expected to improve gradually. Exhibit 4: China leading with 5% production for Alumina; Production breakup (Mt) Jan'12 Mar'12 May'12 Jul'12 Sep'12 Nov'12 Jan'13 Mar'13 May'13 Jul'13 Sep'13 Nov'13 Jan'14 Mar'14 May'14 Jul'14 Sep'14 Nov'14 Jan'15 Mar'15 May'15 Jul'15 Sep'15 Africa & Asia (ex China) North America South America West Europe East & Central Europe Oceania China Source: Industry, Emkay Research Exhibit 41: Monthly alumina production in China (mt) Dec- Feb-11 Apr-11 Jun-11 Aug- Oct-11 Dec- Feb-12 Apr-12 Jun-12 Aug- Oct-12 Dec- Feb-13 Apr-13 Jun-13 Aug- Oct-13 Dec- Feb-14 Apr-14 Jun-14 Aug- Oct-14 Dec- Feb-15 Apr-15 Jun-15 Aug- Oct-15 Source: Industry, Emkay Research Exhibit 42: Monthly alumina imports by China (mt) Dec-1 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Jan-12 Source: Industry, Emkay Research Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Apr-13 China has started taking steps towards that by curtailment of its capacities in Alumina as well as Aluminium to avoid further price fall. According to Alumina Ltd, in 219, total alumina is likely to be in deficit of 1.2 mt taking into consideration that China will be in deficit of ~4 mt at that time. The absolute amount of deficit may vary for different agencies, however, important thing is that it is likely to increase. Jun-13 Aug-13 Oct-13 Dec-13 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Apr-15 Jun-15 Aug-15 Emkay Research January 15,

20 Exhibit 43: Outlook for near market balance for alumina (mn tonnes) ROW China Global Source: Alumina Ltd presentations, Company, Emkay Research Exhibit 44: China 216 alumina curtailments in thousand tonne ,7 Kmt annualized has been announced Henan Shandong Shanxi I.Mongolia Sichuan Total Source: Alcoa presentations, Emkay Research Exhibit 45: China 216 aluminum curtailments in thousand tonne ,9 Kmt annualized has been announced Gansu Ningxia Yunnan Qinghai Henan Sichuan Liaoning Other Total Source: Alcoa presentations, Emkay Research Emkay Research January 15, 216 2

21 Exhibit 46: Alumina: Planned expansions ( ) Bauxite Region Country Company Location Type Comments Integrated Latin America Middle East Asia ex. China Brazil Norsk Hydro Alumina do Para 1,86 Greenfield The 1.86mt project has been shelved by the company awaiting better market conditions. Yes Brazil Votorantim Group Alumina Rondon 3, Greenfield Passed the first stage of the environmental licensing. Looking for JV partners. Yes Saudi Arabia Alcoa-Ma'aden Ras Al Khair 1,8 Greenfield First alumina produced in Q Ramping up in 215. Yes UAE Emirates Global Aluminum KIZAD, Al Taweelah 2, Greenfield Project feasibility studies completed. First phase of 2. million tpa planned to be ready by 217. Phase II could double capacity to 4. million tpy. NO India NALCO Damanjodi 1, Brownfield Approval for mining Yes lease received from Govt of Odisha. DPR under study Anrak Anrak Alumina 1,5 Greenfield Commissioning has been delayed several times amid financial and bauxite supply issues and not expected to start production until 216 at the earliest. Yes Vedanta Lanjigarh 2,35 Brownfield The expansion is on Yes hold due to inability to secure long term bauxite supply. Indonesia PT Antam Mempawah, West Kalimantan Greenfield The 1.2 million tpa project was reported being cancelled as it only received half of the planned state capital injection of funds. The project was planned to start production in 216. Yes Hongqiao Well Harvest Winning Alumina China China Various Brownfield Various Greenfield Source: Alcoa presentations, Company, Emkay Research Ketapang, West Kalimatan 1, 1, Greenfield First 1million tpa phase scheduled to start by the end of 215. Second 1million tpa phase scheduled for 217. Yes Various 1, 8 6 Brownfield Yes Various 5, 4,4 7,2 8 Greenfield Yes Total World 8,8 7,7 6,6 11,95 8 Total China 6, 5,2 6 7,2 8 Total ROW 2,8 2,5 6, 3,895 Emkay Research January 15,

22 Key Financials (Consolidated) Income Statement Y/E Mar (Rs mn) FY14 FY15 FY16E FY17E FY18E Net Sales 67,89 73,828 62,682 68,518 73,648 Expenditure 57,94 56,742 53,61 56,751 6,32 EBITDA 9,869 17,86 9,72 11,767 13,346 Depreciation 5,247 4,137 4,795 5,5 5,215 EBIT 4,622 12,95 4,276 6,762 8,131 Other Income 5,577 6,726 6,341 6,595 7,25 Interest expenses PBT 1,199 19,676 1,617 13,357 15,156 Tax 2,755 7,916 2,973 3,74 4,244 Extraordinary Items (494) 1,484 Minority Int./Income from Assoc. Reported Net Income 6,95 13,245 7,645 9,617 1,912 Adjusted PAT 7,444 11,76 7,645 9,617 1,912 Balance Sheet Y/E Mar (Rs mn) FY14 FY15 FY16E FY17E FY18E Equity share capital 12,886 12,886 12,886 12,886 12,886 Reserves & surplus 18, ,87 117, , ,43 Net worth 121, ,973 13, ,681 14,316 Minority Interest Loan Funds Net deferred tax liability 9,11 11,53 11,53 11,53 11,53 Total Liabilities 13, ,26 141, , ,369 Net block 67,919 66,454 68,659 7,653 72,438 Investment 12,45 9,51 8,5 8,5 8,5 Current Assets 77,428 8,315 82,53 86,216 92,727 Cash & bank balance 4,483 46,28 49,359 51,676 55,61 Other Current Assets Current liabilities & Provision 35,159 22,751 24,766 27,134 3,794 Net current assets 42,269 57,564 57,737 59,83 61,933 Misc. exp Total Assets 13, ,26 141, , ,369 Cash Flow Y/E Mar (Rs mn) FY14 FY15 FY16E FY17E FY18E PBT (Ex-Other income) (NI+Dep) 9,178 21,134 1,617 13,357 15,156 Other Non-Cash items (4,395) (5,227) Chg in working cap 3,379 (9,925) 2, ,74 Operating Cashflow 9,813 5,25 15,345 15,594 17,22 Capital expenditure (6,187) (3,31) (8,) (8,) (8,) Free Cash Flow 3,627 2,173 7,345 7,594 9,22 Investments 2,45 2,94 1,1 Other Investing Cash Flow Investing Cashflow 781 5,657 (6,99) (8,) (8,) Equity Capital Raised Loans Taken / (Repaid) Dividend paid (incl tax) (5,155) (5,65) (5,277) (5,277) (5,277) Other Financing Cash Flow Financing Cashflow (5,155) (5,65) (5,277) (5,277) (5,277) Net chg in cash 5,439 5,797 3,79 2,317 3,925 Opening cash position 35,44 4,483 46,28 49,359 51,676 Closing cash position 4,483 46,28 49,359 51,676 55,61 Emkay Research January 15,

23 Key Ratios Profitability (%) FY14 FY15 FY16E FY17E FY18E EBITDA Margin EBIT Margin Effective Tax Rate Net Margin ROCE ROE RoIC Per Share Data (Rs) FY14 FY15 FY16E FY17E FY18E EPS CEPS BVPS DPS Valuations (x) FY14 FY15 FY16E FY17E FY18E PER P/CEPS P/BV EV / Sales EV / EBITDA Dividend Yield (%) Gearing Ratio (x) FY14 FY15 FY16E FY17E FY18E Net Debt/ Equity (.3) (.4) (.4) (.4) (.4) Net Debt/EBIDTA (4.1) (2.7) (5.4) (4.4) (4.2) Working Cap Cycle (days) Growth (%) FY14 FY15 FY16E FY17E FY18E Revenue (2.) 8.9 (15.1) EBITDA (46.9) EBIT (67.) PAT (42.3) Quarterly (Rs mn) Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Revenue 19,955 19,6 18,13 14,913 18,151 EBITDA 4,743 5,272 4,28 2,237 3,393 EBITDA Margin (%) PAT 3,415 3,545 3,549 1,634 2,261 EPS (Rs) Shareholding Pattern (%) Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Promoters FIIs DIIs Public and Others Emkay Research January 15,