We initiate coverage on Nalco with an outperform rating and Rs 57 target price (potential upside 40.7%).
In a sector globally beset with debt, Nalco stands out as net cash. Even as it embarks on a $900 million refinery expansion, healthy operating cash flows should keep it debt free. Its weaknesses such as the inefficient 0.46 mtpa smelter and 1,200 MW CPP are unlikely to worsen from here.
All of Nalco’s immediate capex plans (till FY18) are to add to its high ROCE long alumina position, enabling it to sell almost 80% of output externally vs 66% now. Alumina’s expected superior price dynamics vs aluminium (Al) further improve its outlook. In any case, given the improving coal supply, its smelter is no longer a drag. Further, unlike other PSUs, Nalco has given precedence to profitability over production in the past, and would not shy away from rationalising Al production if LME prices move adversely.
Nalco currently trades at 8x forward PE. Its discount on EV/Ebitda to Hindalco is at a record high, despite much stronger earnings growth during FY15–17e. Even excluding cash, Nalco would still trade at a discount to Hindalco. We assign a conservative 5.5x EV/Ebitda multiple, lower than long term average of 6.8x and the current peer median of 7.5x. Our R57 target price implies 42% upside to CMP.