NALCO - lowest cost producer of alumina and bauxite

harsh.beria93 · April 17, 2020, 10:17pm

National Aluminium Company Ltd (NALCO) is in the business of manufacturing and selling alumina and aluminum. It is a miniratna company with a government ownership of 51.5% (as of March 2020). NALCO is the lowest cost producer of bauxite and alumina globally. The basic accounting from the last 10 years of financials are shown below.

Accounting:
Over the last 10 years (FY10-19):

Cumulative CFO ~ 11’948 cr., Cumulative profits ~ 9’821 cr., Cumulative EBITDA ~ 14’227 cr.
CFO/PAT ~ 122%, CFO/EBITDA ~ 84%
Cash taxes ~ 4’511 cr., Accrual taxes ~ 4’924 cr.
Tax as a % of PBT ~ 32%
CAPEX (maintenance + growth) ~ 6778 cr.
FCF: 5170 cr. all of which has been paid through dividends ~ 5196 cr.

To summarize, they have been able to convert accounting profits to cash profits. Additionally, the company is net cash positive, generated significant free cash flow which has been paid out to shareholders as dividends (dividend payout ~ 60%). Interestingly, the current market capitalization (5961 cr., 17.04.2020) is only slightly greater than the free cash generated by the business over the last decade. Will we not need aluminum in the future?

Financials
Being a commodity business, their margins are largely dependent on aluminum and alumina prices which are globally determined. In the past, PBT margins have varied between a low of 13% to a high of 28%, with average cyclical margins of 18%. In the past 10 years, the company has faced two major down cycles (FY13-14, FY16-17) followed by upcycles. There is very low bankruptcy risk as the company is net cash positive. Currently, they are in the downcycle with PBT margins going negative in the past two quarters. The bauxite, alumina and aluminum production volumes are shown below. Demand has grown by 3% (by volume) and 8% (by revenue) over the past decade.

Aluminum demand depends on sectors such as automobile, construction, etc. With the current economic downturn, demand has slowed down significantly. Company also faces threat from cheaper Chinese imports.

Key risks

Prolonged economic downturn
Threat of cheaper Chinese imports
Continuous government selling of shares
Bidding for mining rights in other countries (example)
Bribery/scams (example)
Government capital misallocation

Government has been aggressively bringing down stake in NALCO, bringing their shareholding from 80.93% in FY16 to 51.5% in Q3FY20. As government ownership is down to 51.5%, it leaves very little scope for further selling, as government needs to maintain a 51% stake in order to have ownership control.

Valuations
Being a commodity business, margins have to be normalized to adjust for business cyclicality. In order to do this, lets focus on P/sales.

During the FY13-14 downturn, company traded at a minimum valuation of 1 time P/sales
During the FY16-17 downturn, company again traded at a minimum valuation of 1 time P/sales
During the FY10 upturn, company traded at a maximum valuation of 6 times P/sales
During the FY18 upturn, company traded at a maximum valuation of 1.9 times P/sales

The average P/sales over the last decade is 2.15 times. Currently, the P/sales is ~0.65 which is towards the lower end of its valuations. The company has cash equivalents of ~2800 cr. making the enterprise value ~ 3162 cr. (17-04-2020). The current EV/EBIT ~ 5.78 giving an earnings yield of ~17%. Its definitely undervalued (value trap?).

Crystal gazing
The past aluminum downcycles have lasted ~2 years. Lets assume we get an aluminum upcycle in the next 5 years, the previous upcycle ended in FY19. If the company is able to get back to its peak FY19 sales of 11’500 cr. and average valuations of P/sales ~ 2, market cap will be 23’000 cr., thats a ~285% upside.

What is the downside? Well the company has almost half its current market cap as cash. It can happen that market cap goes below cash equivalents, as has happened with a lot commodity companies in the past. The share price of the company largely resembles prices of aluminum (shown below).

I would love more feedback.

Disclosure: invested (detailed portfolio here)

princevegeta · April 18, 2020, 7:47am

Thanks @harsh.beria93 for initiating the topic on NALCO. I have been tracking NALCO and Aluminium prices for last few months and would add to the above as follows:

ALUMINIUM BASICS

Following process summarizes aluminium production process (Source: LME)

Annual Production and Consumption of Aluminium
(Source - Featured Analyses | Trefis)

alm production world

alm consumption world

Country wise Aluminium production as per Geojit (2018)

Aluminium prices globally are determined with reference to prevailing market price in the most actively traded commodity exchage i.e. LME. Due to differential costs of transportation and tariff structures between countries, most of the realized prices are at a premium to the LME prices.

One of the key determinant in the LME price is the prevailing global demand and supply of the metal.

Global Market Trends upto 2018-19

Dominance of China

From 2004 onwards, China has increased its share in world aluminium production from 22% in 2004 to 57% in 2018. Most of this increase is attributable to higher demand from China due to increase in infrastructure, consumption of automobiles and government push.

Low global Inflation

The commodity prices boom during 2004-2008 was partly driven by higher global inflation especially in countries like China.
Since 2008, inflation across key markets has been substantially lower which hasnt increased cost of producing commodities. As a result, prices of many metals have still not crossed their 2008 peaks.

Case in point - Here is the inflation chart of China which has a very similar appearance to the aluminium price chart

china inflation

International trade tensions

A lot of producers including in India had alleged that some countries like China were dumping products in their domestic market. Chinese producers having govt incentives like lower tax, were at a price advantage. Post 2018, with the US-China trade war, tariffs as a whole were on the increase which promotes consumption of domestic produced metal. This has also slowed down the aluminium demand of China, the largest consumer.

Scrap usage

A lot of the western countries have increased recycling of aluminium, further denting demand for fresh metal. To quote an article from aluminiuminsider.com,

"There is a growing tendency by major aluminium processors to use higher amounts of recycled aluminium for making their products. At the same time, there are no reliable and accurate statistics on how much new scrap goes back into the production process over closed-loop schemes, or how much old scrap has replaced orders of primary aluminium.

China will import alloyed aluminium ingots (produced from secondary aluminium) from Europe and elsewhere instead of scrap and may increase exports of semi-finished aluminium products, at higher value and prices than alloyed ingots, while reducing the same (conversion) business in Europe and elsewhere. All things considered, this is the real reason why primary aluminium demand fell so quickly."
(Source - https://aluminiuminsider.com/aluminium-market-oversupplied-demand-growth-flat/)

Current Scenario (Covid-19) - Supply side

Preliminary estimates of Aluminium surplus in March 2020 at LME and Shanghai already are at a more than 10 year high.

This data does not include stocks at unapproved warehouses (which are not counted in LME stocks) and stocks stuck at smelters around the world due to logistical problems. A lot of producers cannot completely shut the smelters and would be producing even with marginal cost of production higher than the market price. As a result the final surplus figure after accounting for all the stocks say after 3-6 months would likely be much higher, maybe even higher than levels seen in 2008. The fear is that this surplus would take much longer to clear out as compared to 2008 since growth in global demand is lower than 2008 and also there is increased usage of scrap.

This has caused LME aluminium prices to crash below USD 1500 levels, at which a lot of the global smelters would run cash losses.

In the near term, the most logical way to increase prices is to shut smelters and reduce the supply.
As per various reports, high cost smelters in China have started to slowly shut

https://www.fitchratings.com/research/corporate-finance/chinese-aluminum-profits-evaporate-low-cost-firms-resilient-30-03-2020

Chalco is the world largest producer of Alumina.
https://www.nasdaq.com/articles/chinas-chalco-weighs-output-cuts-as-aluminium-alumina-prices-hit-lowest-since-2016-2020-04

Likely Bottom?

“Wood Mackenzie estimates that prices under 12,000 yuan a year (roughly 1600 USD) means that “nearly 70% of the Chinese producers will be under water, and that’s certainly not sustainable”. Their profitability is also suffering due to sharp increases in the prices of raw alumina, promoted by bauxite mine supply and transport costs.”

princevegeta · April 18, 2020, 12:28pm

ABOUT NALCO

NALCO is one of the largest integrated Bauxite-Alumina-Aluminium- Power Complex in the Country. The Company has a 68.25 lakh TPA Bauxite Mine & 21.00 lakh TPA (normative capacity) Alumina Refinery located at Damanjodi in Koraput district of Odisha, and 4.60 lakh TPA Aluminium Smelter & 1200MW Captive Power Plant located at Angul, Odisha. NALCO has bulk shipment facilities at Vizag port for export of Alumina/Aluminium and import of caustic soda and also utilizes the facilities at Kolkata and Paradeep Ports. The Company has registered sales offices in Delhi, Kolkata, Mumbai, Chennai and Bangalore and 9 operating stockyards at various locations in the Country to facilitate domestic marketing.

NALCO, being a Navratna CPSE, was granted an additional mining lease of Pottangi bauxite mine (total resources – 75 million tonnes) in Koraput district near its existing refinery on allocation basis. The Indian Bureau of Mines approved the mining plan in July 2018. NALCO plans to add a fifth stream in its existing refinery at INR64.36 billion to increase the refining capacity by 44% to 3.275 million metric tonnes per annum (MTPA) and expects the facility to commence operations by December 2022.

The major Aluminium producers in India are Hindalco, Vedanta, NALCO and BALCO.
Total domestic aluminium capacity as at January 2020 was as follows:

NALCO - 460,000 MT
BALCO - 560,000 MT
Hindalco - 13,46,000 MT
Vedanta - 17,50,000 MT

Source - https://mines.gov.in/writereaddata/UploadFile/Monthly%20summary%20Jan637178804773498074.pdf

Hence in terms of Aluminium Capacity, Nalco is a small player in India. However it derives major component of its profitability from sale of Alumina

nalco segment

Aluminium demand and supply in India (Collated from NALCO Annual Reports)
aluminium qty india

Key Observations

Nalco is an Integrated Aluminium Producer: All of its Alumina requirement is captively consumed from its mines. Others like Vedanta and Hindalco can also import from cheaper cost producers.
Nalco’s Aluminium division is not doing well compared to competitors. Its cost of production is higher and hence in case LME Aluminium price drops below say USD 1700/tonne, assuming a premium of USD 200/tonne, it is likely to make cash losses.
Its Cost of production of Alumina is very low (due to various factors like low manpower cost, low transportation cost) compared to global producers. Hence, it stands to benefit more by directly selling Alumina as compared to using it captively in its smelter. Upto now NALCO has been mainly exporting surplus Alumina as compared to selling it in domestic market.
Why does NALCO export alumina whereas some other producers like Vedanta import alumina? Even I have not found the reason for this question till now. But there has been an interesting development on this aspect in the current year - FY20.

When Vedanta tried to bid for Nalco’s Alumina last year, it “has been repeatedly rebuffed by Nalco, which sells over 1.2 million metric tons of alumina to overseas buyers each year. According to Nalco, Vedanta’s offers have been turned away due to its status as an India-based concern. Vedanta alleges in its filing that Nalco advised it to bid via its holding company in London, contemplating a delivery at sea and a return of the goods to a port in India. Vedanta argues that such an arrangement is far from ideal.“Such process is impractical and unfeasible as it involves substantial loss of foreign exchange as well as duplication and unnecessary burden on the country’s infrastructure of road, rail and port,” said the firm in the filing.”

Source - https://aluminiuminsider.com/vedanta-files-suit-against-nalco-to-tap-into-exported-alumina-stream/

Subsequently Vedanta got Supreme Court decision it its favour allowing it to bid for alumina from Nalco

So from maybe Q4 onwards, Nalco could sell more of its alumina in domestic market and the situation can be win-win for both.

Q2 and Q3 in FY 20 were impacted by were impacted by the sharp increase in power & fuel costs as a result of lower coal supplies from the Mahanadi coal fields (Coal India). Nalco is dependent on Mahanadi coal fields to source coal for the Angul captive power plant. Supplies from Mahanadi, however, got disturbed from 2QFY20 due to heavy monsoon and labor strikes, which required Nalco to purchase power externally and curtail aluminum production.

With Talcher mining operations normalized now, coal supply to Nalco has improved which should reduce power & fuel cost.

At current cash prices of Alumina (LME USD 233) and Aluminium (LME USD 1507), Nalco would surely make cash losses even if production quantities were stable. Since demand has fallen off a cliff owing to Covid, production quantities would fall thereby increasing Cost of Production even more. Hence it is likely that a lot of the Cash in the balance sheet would get used for funding these losses in the next few quarters unless situation normalizes.

I have tried to collate various MOSL reports on what could be Nalco’s Cost of Production of Alumina and Aluminium

Timing of Cycle: It is my personal opinion (I may be wrong) that the global demand for Aluminium will take some time before reaching pre-covid levels. The main argument in favour of this is that the demand from some sectors like Aviation, Automobiles would take a hit due to capex being cancelled / postponed by companies. Hence it is quite likely that FY 21 is a washout year for everybody. This is where Balance Sheet strength will become important and those coming out of this situation will come out stronger.

Risks

Other than those mentioned in first post

Unfavourable regulations by Central and State Govt - eg Non renewal of leases, cancellation of leases due to environmental complaints, high royalty / cess. We have seen similar risks play out for iron ore mining in our country
Conflict in objectives of promoter (GOI) - greater good of society vs interest of shareholders
Dependence on export - Unfavourable tariff structure in customer countries
Dumping of metal from other countries and inability to match prices
Inability to aggressively cut costs in a downturn as compared to Pvt Sector.
Increased usage of scrap for production as compared to freshly mined Alumima

Disc - Invested

alexander · April 18, 2020, 1:27pm

Thanks for the amazing analysis. Would love to understand your take on the valuation as well considering the research you have done.

Also, if Alumina from Nalco is cheaper compared to other sources, wouldn’t it kill off weaker competition in next couple of years and then be a net positive for the company in the longer term?

harsh.beria93 · April 18, 2020, 3:43pm

I have tried valuing the company based on share prices of the past (shown below)

For a commodity company with large fluctuation in margins, we either need to normalize earnings or need to value it on something which is more stable (eg: sales, book value, replacement cost).

Based on data from FY10-FY19,
P/sales → minimum (0.8), average (2.15), maximum (6)
P/BookValue → minimum (0.55), average (1.3), maximum (2.9)
Dividend yield → minimum (0.9%), average (3%), maximum (15%)

Current numbers (as on 17.04.2020) are:

P/sales: 0.64, P/BookValue: 0.58

Dividend yield is a bit useless because they have started reporting losses in the last two quarters and shouldn’t pay a large dividend as it would deplete their cash reserves.

I am not sure about replacement cost, maybe @princevegeta can throw some light on that.

princevegeta · April 19, 2020, 9:49am

Hello

I am not an expert on valuation and valuation in this case would be a highly subjective exercise.

Broadly some of the values mentioned above based on price to sales have a good probability in an upcycle.

One approach would be to do a sum of the parts valuation separately for
1 - Alumina - where Nalco has a favourable competitive position and favourable policy orientation from regulators (At least as of now)
2 - Aluminium - where Nalco’s small size limits its cost efficiencies vs say a Vedanta which can produce aluminium at cost of production of less than USD 1600 / tonne

Another factor to consider is the possibility of large changes in future business activity: Last year Midhani and Nalco have announced a 50:50 JV of setting up a high end lithium-aluminium alloy plant at a cost of Rs 4,000 crore ! Such decisions by the promoter (GOI) can have a very vide range of outcomes in the future value of the business. For eg - NMDC could transform itself from an iron ore miner to an integrated steel producer in next few years.

In the past also the govt had planned for Nalco in a JV for Nuclear Power Plant which has not materialised till date.

Hence these risks would also need to be factored in the valuation.

princevegeta · April 19, 2020, 10:02am

Some more news on the Midhani-Nalco JV for lithium-aluminium alloy plant (Apologies for not covered in thread above)

Alcoa who has successfully added Aluminium-luthium production in to its aluminium production operations in last few years has listed the following useful info about Aluminium-Lithium:

Benefits of Aluminum-lithium

Lithium is the world’s lightest metallic element. When alloyed with aluminum and other metals, the material provides an outstanding combination of strength, toughness, stiffness, corrosion resistance, and high-temperature performance, and at a lower cost than titanium or composites. As a result, Alcoa’s aluminum-lithium materials:

lower the weight of single-aisle fuselage applications by up to 10 percent versus composites;
lower the cost to manufacture, operate and maintain planes by up to 30 percent versus composite-intensive airplanes, and at significantly lower production risk;
contribute to 20 percent better fuel efficiency; and
deliver passenger comfort features equivalent to composite-intensive planes, such as higher cabin pressure, large windows and higher humidity.

Alcoa supplies aluminum-lithium products to all major airframe manufacturers. Beyond aviation, Alcoa supplies aluminum-lithium products for:

Space applications, including on the ULA rocket and developing applications for Space X;
Automotive applications, including parts for commercial trucks, high-performance sports cars and Formula One cars; and
Military applications.

Source - Press Releases | Alcoa Corporation

Some more useful news articles on Nalco’s quest for lithium supplies, production:

ramanhp · April 19, 2020, 4:47pm

ramanhp · April 27, 2020, 4:01pm

harsh.beria93 · May 6, 2020, 7:31am

Updates from management (link):

No demand at all for the floated tenders
Smelters operating at 50-60% capacity utilization
Global metal surplus was projected to increase from 0.1 mn ton in 2019 to 5 mn ton surplus (without taking corona impact into account). Realized scenario is likely to be worse.

harsh.beria93 · June 2, 2020, 6:15am

Updates from management (link):

Expect normal demand to come back by H2FY20
LME prices have gone up from $1421 (decadal low) to $1520 levels
Newly allotted Utkal-D coal block to be operationalized by end of fiscal year

harsh.beria93 · June 29, 2020, 11:58am

Management commentary post Q4 results (link)

Operations scaled down from March because of COVID resulting in operations only at 65-70% of capacity
Currently operating at 90-95% capacity
Almost no sales in May
Focusing on exports as domestic demands are very low
Peak excavation of bauxite is in first quarter which has been badly affected this year and will adversely impact FY21 number. It’s a tall ask to even reach FY20 numbers

eyesice · July 7, 2020, 3:27pm

Hi Harsh,
I have a query. The topline generated from Aluminum is usually greater than Alumina. However the bottom line is always dragged down due to the expenses incurred from cost of production of Aluminum. Is this correct? Where can we find the typical margins of Aluminum production from competitors like Hindalco?

From Q4 Results
EBIT Margins 2019

Alumina - 32%
Aluminum - 11.3%

EBIT Margins 2020

Alumina - 13%
Aluminum - (5%)

From what I see in the latest investor presentation of Hindalco - below are the production and margins for Alumina and Aluminum

However, EBIT margin was still 17% (I believe this is the Aluminum + Alumina combined) compared to the dismal performance of NALCO. Is it because NALCO cannot operate at scale compared to a giant like HINDALCO?

harsh.beria93 · July 7, 2020, 5:53pm

Here are the EBIT margins for aluminum division of Hindalco. In top of cycles, it can go above 20% but this will not go on for a long time. I guess peak cyclical margins are 12-15%.

For NALCO peak EBIT margins seem to be ~12%. We have to keep in mind that NALCO is not the lowest cost producer in aluminum, its HINDALCO. NALCO is competitive in alumina and bauxite (global leader). All data taken from screener (@ayushmit its okay to post this?)

eyesice · July 8, 2020, 3:08pm

Thanks for sharing this. A couple of observations

Hindalco does not provide exact margins for its Aluminum sales. The Aluminum business section shows the combined sales of Utkal Alumina + Aluminum + Aluminum VAP. So I think, we cannot exactly compare the margins to NALCO. However, this is a good enough guesstimate.
This also means that we should be looking at NALCO as an Alumina producer whose bottom line will be dented due to the production of Aluminum during down cycles. The OPM for Aluminum is typically -4% to -6% during the down cycles. The interesting thing to note here is that in the last decade, FY-20 witnessed the lowest Alumina margins of 13%! This is highly unusual considering the avg Alumina margins hover in the range of 18 - 22 %.

A quick look at US Alumina Price History shows that at current levels of 275 USD per tonne, we have reached a deep bottom of the Alumina (and Aluminum cycle). How far will it go further? Only time will tell

harsh.beria93 · July 8, 2020, 3:34pm

Just to add, these are alumina 1-month forward contract prices traded on LME. Prices have gone down quite a bit, lets see if and when prices recover.

ayushmit · July 9, 2020, 5:06am

Hi @harsh.beria93 - its totally ok to share extracts.
In ref to Nalco, I feel the blended margins are not bad for the company. They do make good money by exporting aluminia. I don’t know if Nalco is the lowest cost producer but several reports, credit rating etc say that its one of the lowest cost producer. The numbers were badly impacted in recent quarters due to 1. lower prices 2. issues in coal block impacting their power cost. There used to be articles about additional coal blocks etc which will help the company reduce cost further and also go for an expansion after a long time.
Based on my interaction with some industry people, it is believed that Nalco trades at substantial discount to replacement value and the biggest comfort is that the company is debt free.

Regards,
Ayush
Disc: Invested in family accounts and client accounts.

harsh.beria93 · July 11, 2020, 9:13am

Management updates (CNBC interview)

Currently operating at ~90%
Fear increased in the labor force (specially in Maharashtra, Chennai regions)
Global production has increased, it will be surplus conditions
Still debt free
Full year CAPEX guidance: 1000 cr., 1st quarter CAPEX was >90 cr. spent
Alumina prices: $260
Aluminum prices: $1650 (prices increased by $40 overnight)

ayushmit · August 4, 2020, 12:53am

Very nice work @harsh.beria93 on the valuation framework for Nalco and multiple ways of looking at the company. I have been pursuing few companies in the commodity space as a basket and I feel that some of them are very attractive on valuations. Some of these cos seem to be at multiyear low and at substantial discount to replacement cost and BV. For a patient investor for next 2-3 year. For eg - in Nalco, like you mentioned, the stock is at multi-year low from multiple valuations perspectives - like Price to Sales, Price to BV, Div yield etc. From my side I did a very rudimentary analysis of the long term chart of the company and one can observe that the price is at kind of 15 year low despite the company being much bigger in size. The good thing with Nalco is that they are debt free and have a good dividend track record.

Interestingly the international aluminium prices have moved up to pre-covid levels and are up almost 20% from lows:

The recent performance of the company has been really poor in recent quarters as they had some issues in procurement of coal and power (biggest cost) in recent times but the same seems to have been resolved in recent months. They also got mining lease for a coal block recently which is expected to bring substantial saving in a couple of quarters- NALCO Gets Mining Lease For Utkal-D Coal Block
There have been articles about some major capex lined up and possibility of substantial cost savings.
There was a good detailed research report by B&K securities on the company recently. One may look for that to understand more.

Negatives - 1. PSU 2. Some of these are in-efficient - one can see the same as employee costs are very high 3. Company hasn’t grown much in terms of volumes over the years

Disc: Invested in family accounts and PMS.

nithin_Shenoy · August 4, 2020, 5:20am

Just wanted to ask is Maan Aluminium is also the same peers?