ALUMINIUM INDUSTRY ANALYSIS

Prof. Sanjeev Patkar

VALUE CHAIN ANALYSIS

VALUE CHAIN ANALYSIS

Mining of the Basic Raw Materials

(Bauxite, Caustic Soda, petro coke, coal tar, LS/FS furnace oil)

Alumina

Aluminum1.Primary aluminum, such as molten metal, re-melt ingot and sheet ingot. It is made from the electrolysis of alumina

2.Recycled aluminum

Upstream ProcessesDownstream

Processes

Alumina is then reduced to aluminium

through the electrolytic process. It

is also known as aluminium smelting

Bauxite is refined to alumina by mixing it with caustic liquor

These are the residual processess such as annealing, coating, leveling or slitting to achieve the desired thicknesses and metal properties.

There are 2 processes from where the aluminium products can be manufactured:1.Sheet Ingot – that require sheet ingot, a rectangular slab of aluminium as a starter material

2.Continuous casting mills – that convert molten metal directly into semi finished sheet

The finished products can be divided into 3 broad categories.

Aluminium rolled productsExtrusions FoilsRedrawn rods

The end use markets for aluminium are as follows:

1. Construction (22%) 2. Packaging (15%) 3. Transportation (28%) 4. Electrical (12%) 5. Engineering (10%)6. Consumer Durables (9%)7. Others (4%)

Downstream Processes

100 units of bauxite will give me 33 units of alumina which in turn will give 18 units of aluminium

PORTER’S 5 FORCE MODEL

Porter’s Five Force Model

Bargaining Power of Suppliers

Raw Materials

Bauxite(which is a ore

containing aluminium)

Power(Petro Coke, LS/FS

Furnace Oil, Coal Tar)

Alumina(this is used as a raw

material for downstream

aluminium producers)

Bargaining Power of the Suppliers - Bauxite

Bauxite contributes significantly in the cost of production

Abundant Bauxite Reserves

Presence of captive Bauxite MinesIndia has 3bln

tonnes of Bauxite reserves which

account for 6% of world reserves

The contribution of Bauxite to the cost of production is the second highest after

power

Bargaining Power of the Suppliers - Power

Presence of Captive Power Plants

Power constitutes to 35%-40% of the total production costs and provides significant advantages to the Indian producers

As the selling price of aluminium falls below the cost of production many players have also started selling power

Bargaining Power of the Suppliers - Alumina

A decrease in the prices of alumina reduces the cost of non integrated players but is detrimental to the interests of the integrated players

Alumina accounts for 32% of the costs

Bargaining Power of the Buyers

The government has imposed a safeguard duty of 35% which would protect the domestic players

The import duty stands at 5% and an additional surcharge of 3%

The proportion of rolled products is only 0.2% for NALCO and13% for Hindalco

The company has to adhere to demanding customer standards in value added products segment

Threat of Substitutes

Aluminium is still an under researched metal

The main substitutes for aluminium are plastic, wood and glass.

The Indian Aluminium Industry comprises of only 2 dominant players.

Potential Entrants

The Aluminium Industry is capital and technologically intensive

The new entrants will also have to build their own captive power plants

Power constitutes 35-40% of the

operating costs

Factors Affecting Supply

Production Capacity: The addition of production capacity requires large capital investments and significant plant construction or expansion, and typically requires long lead-time equipment orders.

Alternative Technology: Advances in technological capabilities allow aluminum rolled products producers to better align product portfolio and supply with industry demand.

Trade: The imposition of a safeguard duty of 35% would lower imports in the country

In 2006 China accounted for 25% of the total primary aluminium production in the world. It has cut production to the extent of 4 mln tonnes

Factors Affecting Demand Economic Growth

Substitution Trends: Manufacturers’ willingness to substitute other materials for aluminum in their products and competition from substitution materials suppliers also affect demand.

Downgauging

Seasonality: Cold drinks and construction in the summer

Scope for Growth: The per capita consumption of aluminium in India continues to remain abysmally low at 0.6 kg as against nearly 25 to 30 kgs in the US and Europe, 15 kgs in Japan, 10 kgs in Taiwan and 3 kgs in China.

BUSINESS MODEL

NALCO

Business Model

Bauxite Mining

Alumina/ Power

Aluminium

Semi – fabricatio

nFabrication

Cost Leadership

Access to cheap resourcesEnhance Scale

Improve Efficiency

The company is enhancing its scale, using its captive resources to become one of the lowest cost producers of aluminium in the world

Sizeable Global Presence

2004-05

2005-06

2006-07

2007-08

0

200000

400000

600000

800000

1000000

1200000

1400000

Domestic Sales (MT)Export Sales (MT)

A sizeable proportion of NALCO’s sales are from the overseas markets

NALCO has a 4% market share in the global Alumina trading space

Cost Leadership

Cost Leadership

Nalco owns and operates one of the largest one of the world’s largest and highest quality bauxite mines (210 mln tonnes)

It has mines close to its smelters in bauxite

Power plants are also in close proximity to the smelters

Cost competitiveness to rise furtherCost of power=U S cent 1.25per unitNew cost of power using captive coal=0.75cent per unitSavings=0.5 cents per unitPower consumption=16000KwhCost reduction =0.5*16000 =USD 80 per tonne

Aluminum operating cost

2007 2010

COMPARATIVE PERFORMANCE MATRIX

NALCO and HINDALCO

Comparative Performance Matrix

2004-05 2005-06 2006-07 2007-080

20000

40000

60000

80000

100000

120000

140000

per MT realiza-tion Aluminium Products Hin-dalco

per MT realiza-tion Alumina Hindalco

2004-05 2005-06 2006-07 2007-080%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Total Aluminium Products Sold (MT)Total Alumina sold (MT)

2004-05

2005-06

2006-07

2007-08

020000400006000080000

100000120000140000160000180000

per unit realization AluminiumProducts NALCOper unit realization Alumina NALCO

2004-05

2005-06

2006-07

2007-08

0%10%20%30%40%50%60%70%80%90%

100%

Total Alumina Sold NALCO (MT)Total Alumina Sold NALCO (MT)

NALCO – per unit realization HINDALCO – per unit realization

NALCO – TOTAL realization HINDALCO – TOTAL realization

Raw Material Consumption

2005 2006 2007 20080%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Crystal growth modi-fierLimeAluminium fluorideC.T.PitchC.P.CokeCaustic soda

2005 2006 2007 20080%

10%20%30%40%50%60%70%80%90%

100%

Crystal growth mod-ifierLimeAluminium fluorideC.T.PitchC.P.CokeCaustic soda

2004-05

2005-06

2006-07

2007-08

0%10%20%30%40%50%60%70%80%90%

100%Pitch

Ammonia

Rock Phosphate

Calcined Petroleum Coke

Caustic Soda

Aluminium Fluoride

Aluminium

Bauxite (including cost of own produc-tion)

2004-05

2005-06

2006-07

2007-08

0%10%20%30%40%50%60%70%80%90%

100% Pitch

Ammonia

Rock Phosphate

Calcined Petroleum Coke

Caustic Soda

Aluminium Fluoride

Aluminium

Bauxite (including cost of own produc-tion)

NALCO – per unit realization

HINDALCO – TOTAL realization

HINDALCO – per unit realization

NALCO – TOTAL realization

CASH FLOW ANALYSIS

NALCO

Share of Activities – Cash Flows

Particulars 2006 2007 2008

Cash Flow from Operating Activities

1965.42

2723.62

1901.91

Cash Flow from Investing Activities

-233.05

-641.94

-1544.1

3

Cash Flow from Financing Activities

-293.87

-588.86 -527.85

Greater than 99% of the total contribution

of the investment cash outflows are

from the purchase of Fixed Assets

Greater than 99% of the total contribution of the financing cash outflows are from the payment of Dividends

Cash Flow Ratios

Ratios Formula 2006 2007 2008

Cash Flow to Revenue CFO ÷ Net Revenue 0.41 0.46 0.38

Cash Return on AssetsCFO ÷ Average Total Assets 0.29 0.32 0.19

Cash Return on Equity CFO ÷ Average Shareholder's Equity 0.37 0.40 0.23

Cash to Income CFO ÷ Operating Income 0.76 0.75 0.83

Cash Flow Per Share(CFO - Preferred dividends) ÷ no. of common shares outstanding

30.50 42.27 29.52

Reinvestment CFO ÷ Cash Paid for long term Assets 8.43 4.24 1.23

Investing and Financing

CFO ÷ Cash Outflows for investingfinancing Activities

3.73 2.21 0.92

VALUATION

NALCO

Sales Revenue

1,600

1,700

1,800

1,900

2,000

2,100

2,200

2,300

Primary Alu-minium Produc-tion

0

500

1000

1500

2000

2500

Alu-minium LME In-vento-ries

Thousands o

f M

T

•There has been a reduction in demand of primary aluminium production worldwide

•This is also evident from the rising LME inventories

•The per unit realization of the aluminium producers has also declined due to a fall in LME prices

Demand Scenario

Construction, Transportation and Packaging account for about 65% of the industry wise consumption

Europe, North America and China account for about 71% of the total annual consumption

Both the major contributors of consumption have been facing a slowdown

28%

22%15%

12%

10%

9%

4%

Transport

Construction

Packaging

Electrical

Engineering

Consumer Durables

Others

21%

17%

33%

20%

9%

Europe (Ex Russia)North AmericaChinaAsia (Ex China)Rest of the World

48%

25%

9%

2%

2%

1%

2%

11%

Chalco Chinese Small Aluminium Pro-ducersOther Global

ProducerAlcoa

Vimetco United RusalVedanta Norsk Hydro

Valuation Ratios

Ratios2005-06 2006-07

2007-08

P/E 10.4 6.8 7.9Price/book value 2.04 1.92 2.26Price to cash earnings per share 6.12 5.43 10.54EV/EBITDA 3.216 2.815 5.963EV/Sales 2.02 1.87 3.32Mkt Cap/ Sales 2.48 2.49 4.02Dividend yield 1.57 2.56 1.69

Ratios2005-06 2006-07

2007-08

P/E 10.4 6.7 13.9Price/book value 1.369 1.4604 1.0334price to cash earnings per share 6.05 5.45 4.97EV/EBITDA 8.15 4.81 7.31EV/Sales 2.09 1.14 1.5

Mkt Cap/ Sales 0.7732 0.77321.07143

8Dividend yield 18.54 11.64 18.08

Growth Phase

Year Dividendno. of shares DPS PV of Dividend

2004     4  

2005     4  

2006     5  

2007     7.5  

2008 386.6   6  

2009 319.9 644309628 5 4.4

2010 380.1 644309628 5.9 4.7

2011 485.6 644309628 7.5 5.3

2012     7.8 14.4

Continuing Value

Intrinsic Value = (7.8/(0.122 – 0.035)) = 89.7

=89.7 (1/1.122^4) = 56.6

Total Value = 14.4 + 56.6 = 71

Valuation

Pessimistic Most Likely Optimistic

Discount Rate 12.4% 12.2% 12%

Growth Rate 3% 3.5% 4.5%

Growth Phase Value 14.4 14.4 14.5

Terminal Value 51.7 56.6 66.7

TOTAL Value 66.1 71 81.2