by Sandhya Krishnan
HEG, a diversified Indian business group, engaged in the manufacture and export of graphite electrodes, saw quite a bit of action recently, as far as stock prices are concerned. Prices surged over 21% in the last four days (as on 16 Sept 2019), before falling sharply today as investors booked profits, uncertain of outcomes. The stock also saw high volumes change hands - around 50,000 shares were traded on the BSE bourses in comparison to a 2-week average of 54,000 shares.
In spite of sluggish performance in Q1FY20, the management is optimistic about HEG being better positioned, compared to peers in the graphite industry, given the tough economic scenario, globally.
‘’What gives us...confidence is that if you have gone through the results and public discussions that all other graphite companies have had, everybody seems to have cut back on their production by about 15-20%. Except HEG, nobody has yet announced any expansion. Our results in this quarter, although lower than the previous quarters, still remain one of the strongest in the industry, ’’ the management said.
Quick takes:
- Topline declined to Rs 817 cr, a 48.6% YoY drop from Rs 1587 cr. The lower sales volume relative to production levels has resulted in higher inventory holding
- Exports comprise a whopping 75% of production. Exports negatively impacted owing to imposition of sanctions on Iran and political developments in Turkey
- Operating income registered was Rs 387 cr, a huge drop from Rs 1196 cr in Q1FY19
- PAT stood at Rs 234 cr, a drastic 69.6% yoy decline from Rs 770 cr in Q1FY19
- Boasts of being long term debt free
- Has entered into an agreement with a Government utility company for power purchase, which would reduce production costs of graphite electrodes
- Capacity expansion from 80,000 tons to 100,000 tons is on track and expected to be commissioned by early 2022. The capex investment estimated is to the tune of Rs 1200cr, with Rs 400 cr expected to be deployed in each of the next 3 years
- The management believes that even with 1.5-2% p.a. growth in the electric arc furnace industry, there is enough room for the enhanced 20,000 tons graphite capacity to be absorbed.
- Healthy capacity utilization of 85% as of Q1FY20 (82% in Q1FY19). Management guidance remains around 75% for FY20e.
- Cash rich company with Rs 1650 cr as of Q1FY20. HEG contemplating acquisition led foray into lithium ion space that finds application in electric vehicles.
Q1FY20: Sluggish performance, margin pressures to continue in FY20e
Graphite electrode is a vital input in steel production, which in turn is the backbone of the real estate sector. Some analysts believe that the Finance Minister’s Rs 70,000 cr economy booster package to the export and housing sector might have positively impacted investor sentiment towards graphite sector stocks with resultant hike in prices and volumes traded of HEG.
Globally however, the prices of graphite electrodes have slumped. This is attributable to the declining steel demand owing to the global economic slowdown. World Steel Association (WSA) forecasts global steel demand to touch 1752 MT in CY20, a modest 1.0% growth over 2019. Steel production fell 4% in 1HCY19. The subdued steel demand does not augur well for the industry.
The dumping of cheap Chinese electrodes has limited the pricing power of domestic electrode players, forcing them to reduce prices. The margins of HEG’s 20-25% product mix has been adversely impacted by intense Chinese competition in low-grade high power (HP) electrodes.
Additionally, the supply shortage in electrodes in 2017 and 2018, resulted in customers stocking up on excess inventory (slated to be 40-45% excess over the requirement) in 2019. This resulted in an excess production vis a vis sales situation for HEG. The management expects the inventory levels to correct in the coming quarters and volume sales to resume by end of FY20e.
The scarcity of needle coke, an essential raw material in Ultra High Power (UHP) graphite electrodes, is fueling its price rise and further adding to the woes. Margin pressure is expected to continue in the wake of rise in raw material i.e. needle coke prices and slump in final product i.e. graphite electrode prices.
The company foresees stabilization in the prices of UHP electrodes which had peaked in the past 2 years. HEG has proactively diverted needle coke resources to enhance production of UHP electrodes. Since UHP prices are more lucrative than HP prices, HEG has comparatively hiked UHP production by 5-7% yoy as of Q1FY20.