In its spree to meet the fiscal deficit target, Government of India has proposed an offer for sale (OFS) of equity shares of National Aluminium Company Limited (NALCO) tomorrow i.e. 15th of March, 2013. The offer for sale will be for 257,723,850 equity shares constituting 10% of the paid up equity share capital. Given the low floor price, cheap valuations and healthy prospects for alumina despite subdued demand for aluminium, investors are recommended to participate in the process.

Details: The government intends to offer 5% initially with an option to sell another 5% if the demand stands out strong. Due to the limited free float, the floor price has been kept low at Rs 40 and will help in raising Rs 1030 crore. The OFS was initially proposed in November, 2012 but due to poor results in the second quarter, it was deferred on valuation concerns.

Business: After a subdued performance in the first half of FY13, Nalco emerged strongly in the latest quarter. Issue regarding coal sourcing- a major concern- is now abating. The company sourced 80% of its coal requirement through linkages and the remaining 20% through imports and e-auctions in the third quarter. With the acquisition of land for Utkal coal block, dependency on purchased coal will reduce in an year. Captive production of coal to the tune of 2 million tonnes (MT) will reduce costs substantially as it is 20-25% cheaper than the linkage coal. Even the cost of imported coal has declined by 15% in the fourth quarter of FY13 on a y-o-y basis.

Cost of other raw materials such as calcined pet coke and coal tar pitch has also been declining and caustic soda prices have more or less stabilised after increasing by 40% in last two years. Given the weak demand and price of aluminium, management’s decision to restrict aluminium production to 400,000 tonne comes as a positive move, as it will help selling more quantities of alumina, where the economics are favourable.

Although the dynamics in aluminium appear weak globally, the outlook for alumina remains strong thanks to the recent export restrictions introduced by Indonesia, which is a major supplier of bauxite globally. This is supported by the growing aluminium smelting capacities in China, which are mainly dependent on imported bauxite or alumina. China’s aluminium smelting capacity is expected to continue growing at 8% CAGR over next three years, maintaining the strong outlook for alumina. Analysts expect the alumina prices to increase from the current levels of $330 to $385 per tonne in 2014.

Risks: A delay in the commencement of Utkal coal block and resumption in the bauxite mines, though less probable, might impact the earnings growth. Also, a disappointment in demand of alumina from China leading to price fall will moderate the performance of Nalco.

Valuations: The stock of the company currently trades at a historically low Price-to-Book-Value of 0.8. Given a healthy improvement in margins as a result of lower costs and higher alumina realisations, it looks attractive in term of EV/EBIDTA, which stands at 5.51. The balance sheet has been debt free and future expansion plans will primarily be funded from internal accruals.

Outlook: With strong balance sheet, captive bauxite mines and captive power generation, the offer for sale at a floor price of Rs 40 looks highly attractive and investors are recommended to participate.