Aluminium prices have halved during the year and are expected to remain subdued in the near term. The global credit squeeze witnessed at the start of the year worsened in Q3 2008.
Spending ability of corporates as well as individuals fell as lending by financial institutions plunged. This led to a collapse in housing and transportation, which together account for 50% of the global aluminium demand.
Despite the slowdown, Chinese producers have not aggressively cut production. This could result in an expansion in the supply-demand surplus over the next two years.
We expect the current average marginal cost to drop from $2,140 per ton to $1,900 per ton in 2009 aided by lower raw material prices. We expect prices to trade below the marginal cost in 2009 on account of significant surplus expected in the market.
NALCO secures most of it coal for its captive power plant from Coal India Ltd (CIL). During FY09, CIL has been unable to meet its production target and is likely to miss it again in FY10E.
NALCO is expected to source 30% of coal requirement through e-auctions and imports as output from the company’s captive mines would be delayed. Usage of expensive coal is expected to keep power costs high thereby reducing the company’s OPM.
As per the management, the current average cost of production of alumina is $165 per ton and that of aluminium is $1,500 per ton. This is not expected to reduce before February ’09 on account of the inventory with the company.
Thereafter, the reduction in raw material prices is expected to bring down the cost of production merely by $75-100 per ton by the end of Q4FY09.
NALCO’s new capacity will have a minimal impact in FY10 as demand outlook looks bleak and prices are expected to remain subdued. The cost advantage the company enjoyed over its competitors is likely to shrink as input prices have come off.
At current market price of Rs198/share, the stock trades at FY10E EV/EBITDA of 7.9x, which is at a premium to its historical multiple of 6x. We recommend a SELL on the stock with a target price of Rs159 per share.