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Buy Nalco, Hindalco, Sterlite – Citi

May 12, 2008

Breaking NewsJust a while ago Citigroup Analysts have turned BUYERS into Aluminium stocks in India [Upgrading NALCO and Hindalco from SELL to BUY]. Citi’s global Analyst, expects an emerging power crunch and shortage of high quality bauxite to cause a shift in the competitive landscape for aluminium, driving aluminium & alumina prices up. New aluminium prices are US$3,600/t (+22%) in FY09 and US$4,500/t in FY10 (+71%).

The upward trend in electricity prices and security of supply is a key challenge in countries with major aluminium smelting capacity such as China, South Africa, Brazil, and the USA.

Hindalco:
Hindalco is a low-cost integrated aluminum producer (~500,000 tpa) with 1.5m tpa of alumina capacity, and has the advantage of captive power and bauxite. It has a strong domestic market share in primary aluminium; and a dominant 60-65% market share
in sheet products.

Hindalco has ambitious expansion plans to triple both its alumina capacity (to 4.8m) tpa and its aluminium capacity to ~1.5m tpa, to be completed in stages during 2010 to 2013. These will have matching power and bauxite and some captive coal.

Citi is upgrading HINDALCO to Buy and raising its target price to Rs240 following our improved aluminium outlook for the next three years. Target price is based on 12-month forward consolidated P/E of 9x.

Nalco:
Nalco believes that it is among the three lowest cost alumina producers globally due to its good quality bauxite, low transport cost (the conveyor belt uses gravity to transport ore to refinery at foothills) and advanced technology.

The company expects to complete its ongoing expansion by Dec 2008 (capex Rs46bn), resulting in a 33% hike in both alumina (to 2.1m tpa) and aluminium capacities (to 460,000 tpa).

Based on the new forecasts (but with 7-11% discounts), more favourable Rs/$ exchange rates and slightly higher volume assumptions, Citi upgrades EPS by 83% in FY09E and 268% in FY10E. Citi has set a new target price of Rs 546, 12-month forward P/E of 10x, the mid-point of Nalco’s one-year trading range of 9x-11x.

Sterlite:
Citi has raised earnings estimates by 6% in FY09E and 28% in FY10E given new aluminum forecasts and exchange rates. They continue to value Sterlite at 10x P/E but roll forward to June 2009 (12-m forward), arriving at a value of Rs984. To this, add the value of the power business (Rs69/share) for a target price of Rs1,053.

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