Nalco’s capital expenditure plans could squeeze cash flows and check stock price

Nalco refinery expansion project is causing a bit of a flutter. “Nalco is proceeding with its return dilutive alumina refinery expansion project of Rs6,000 crore. We estimate a negative free-cash-flow in FY2021-23 (estimates) as it would use all its surplus cash and NACL (Nalco) would require to raise debt in FY2023 (E) to continue its expansion spends," said Kotak Institutional Equities.

The stress on cash flows could also impact its high dividend yields in the coming years. Nalco’s dividend yield works out to about 4.2% on FY20 payouts.

Meanwhile, the company did better than the Street's expectations on the operations front in Q1 thanks to cost cuts and lower commodity expenses. Nevertheless, earnings before interest, tax, depreciation and amortization came in lower by about 39% year-on-year on a revenue decline of 34% y-o-y. Cost of coal and carbon were lower during the quarter and to an extent helped offset the fall in operating profits.

Production was hit due to covid-19 with both alumina and aluminium production contracting by 20% and 11% year on year. But production is expected to be better in the next quarter.

One positive is that the market dynamics appear to be improving for the aluminium industry. Aluminium prices have increased about 20% in the international markets so far this financial year, and could aid the operating profit growth of Nalco. Demand from China has been steady, while a weak US dollar could continue to support prices.

But one worry for the aluminium market is the high inventory levels. “A surplus market and weak costs should cap further upside in aluminium prices. Alumina prices have rallied by 18% YTD FY2021(E). The market remains well supplied despite the recent disruption at Alunorte, Brazil and we see limited upside," said Kotak’s analysts in the report.

Of course, analysts have raised expectations of earnings in FY21 on the back of the lower base and better realizations.