Riding Piggyback On Demand For Power And Steel

HEG Limited
RIDING PIGGYBACK ON DEMAND
FOR POWER AND STEEL 

HEG Limited, incorporated in 1977, is the second largest graphite electrodes (GE) producer in India and fourth largest in the world. GE is essential for making steel through electric arc furnace (EAF) route. The company produces two grades of graphite electrodes-Ultra High Power (UHP) and High Power (HP) -used in producing steel through the EAF route. The order booking share between HP and UHP is about 60 per cent and 40 per cent respectively. This business segment contributes 97 per cent to the company’s topline. 

In addition to servicing large domestic steel players, HEG supplies large proportion of its production volume to the top 20 steel companies in the world. The company exports approximately 60 per cent of its production to about 30 countries around the world. HEG’s export prices are similar to those of Japanese and American companies' prices and these countries do not impose any duty on import. HEG commissioned its last capacity expansion way back in February 2012 wherein it installed a capacity of 14,000 tonnes, incurring a capex of Rs225 crore 

The company also possesses power generating assets (thermal and hydel) with a cumulative capacity pegged at 76.5 MW. Both the thermal power and hydel power primarily caters to its graphite electrode manufacturing needs and the surplus power generated is sold in the market through IEX and bi-partite power purchase agreements with open access consumers. This business registered a turnover of Rs208 crore in FY17 as against Rs200 crore in FY16, growing by 5 per cent, due to improved power generation. The hydro-power business is generating stable income and costs are coming down YoY and, as a matter of fact, 75-80 per cent costs are just interest on debt which will decrease every year due to repayment. This segment is expected to be a major source of support to enhance organisational profitability.

HEG has an integrated facility at Mandideep, Madhya Pradesh which has an installed capacity of 80,000 MTPA and is the largest manufacturing capacity of graphite electrode under single roof in the world. The plant also has a co-generation power capacity of 77 MW.

INDUSTRY OVERVIEW 

Steel Industry : World Steel Association (WSA) reported a growth of 5.6 per cent in world crude steel production to 1266 million tonnes for the first 9 months in 2017, as compared to the same period in 2016. WSA forecasts global steel demand to reach 1648 MT in 2018 from 1516 MT in 2016. 

India is now second largest steel producer after China, overtaking Japan. The easy availability of low-cost manpower and the presence of abundant iron ore reserves makes India competitive in the global steel landscape. 

The outlook for the steel industry appears promising, especially due to the government’s thrust to infrastructure creation and housing. To achieve steel capacity build-up of 300 MT by 2025, India would need to invest USD 210 billion over the next decade. The government also imposed anti-dumping duties on cold-rolled steel products from Korea, Japan, China and Ukraine and another six countries for 47 different hot-rolled steel products. Also, the National Steel Policy 2017 enumerates Indian government’s plan to enhance the per capita steel production by over 2 times from 61 kg in 2015 to over 160 kg in 2031. The share of EAF will keep on increasing due to its relatively more eco-friendliness and increased availability of scrap at lower costs. The total steel of EAF in India is just about 30 per cent of total steel as compared to 60 per cent in the US and 44 per cent in western Europe. 

Graphite electrode sector: Traditionally, the global GE capacity has been about 9,00,000 MTPA (ex-China) while demand was only about 6,00,000 MTPA. This resulted in not so happy times for the GE industry. However, in recent years, global GE industry witnessed supply side restructuring as subdued GE prices led to closure of about 1,90,000 MTPA GE capacity. Since then, the fortunes of the graphite electrode sector have been on the rise. The key triggers have been the consolidation of the graphite electrode market globally; increase in steel production through EAF route (outside China), coupled with an increase in global steel prices and the closure of steel capacity in China. 

Needle coke is the main raw material which comprises 40-45 per cent in total raw material required for electrode Other raw material includes power, windup pitch, fuel oil, gases etc. However, the availability of needle coke continues to pose challenges to the electrode makers in achieving higher capacity utilisation since needle coke is finding an alternate usage in the industry to make lithium Ion batteries, thus putting pressure on supply side.

According to Technavio’s market analysts, the global GE market is expected to reach around 2 million metric tonnes by 2020 in terms of volume growth of 10.16 per cent CAGR during the period. Globally, the demand for UHP graphite electrodes is anticipated to account for around 67 per cent of the total graphite electrode market by 2020. Also, it takes a minimum of 18 to 24 months for any growth in the capacity in the graphite electrode space. 

Scenario in China bodes well: China has been exporting approximately 115-120 MMT of finished steel to more than 200 countries over the past couple of years, leading to reduced production in these countries. However, the crackdown on pollution by Chinese government last year led to closure of some identified highly polluting industries. As a result, exports from China over the first nine months of 2017 slumped by almost 30 per cent to 60 million tonnes. The Chinese exports of steel products were 5.1 million tonnes in September 17, lowest monthly total since February 2014. Also, countries like India, US, Mexico have imposed import duty on electrode exports from China. 

FINANCIALS 

On an annual basis, the company posted 8.28 per cent increase in its revenue to Rs896.02 crore in FY17 from Rs827.54 crore in FY16. However, the company registered a PBDT decrease of 51.88 per cent to Rs33.05 crore in FY17, as against PBDT of Rs68.68 crore in FY16. The company reported a loss of Rs50.11 crore in FY17 as against a loss of Rs15.15 crore in FY16. 

During Q2FY18, HEG reported net sales of Rs409.54 crore, thus registering a growth of about 111.1 per cent on a YoY basis. Also, HEG’s EBITDA margin improved significantly to 46.3 per cent in Q2FY18 as against 11.4 per cent reported in Q1FY18. The company reported PAT for the first time after reporting losses for seven consecutive quarters; it reported an impressive turnaround at the PAT level, reporting a profit of Rs113.7 crore. This was due to higher capacity utilisation and better realisations. HEG’s margins are likely to improve further before stabilising, backed by improvement in selling price of GE, utilisation rate and operational efficiency. 

VALUATION 

The company maintained a PE ratio of 111.03x, as against its peer Graphite India's 81.66x. The company has a negative return on equity of 5.54 per cent and a return on capital employed of 0.46 per cent. The company has a debt-toequity ratio of 0.78x and price-to-book value of 11.16x. HEG has repaid Rs97 crore debt in FY17 and is expected to repay Rs150 crore debt in FY18. The promoter’s stake in the company has increased from 58.79 per cent in the June quarter to 61.04 per cent in the September quarter. 

CONCLUSION 

Due to robust upstick in electrode prices, HEG has been one of the good wealth creators for investors with the stock price surging over 1350 per cent in the last one year. However, considering the risk of volatility in raw material prices and steel production primarily through EAF route, we recommend our reader-investors to HOLD the stock for now.