IGI Logo

Company Background & Product Highlights

Incorporated in 1977, HEG Limited (HEG), a part of LNJ Bhilwara Group of Mr. Ravi Jhunjhunwala, is the second largest graphite electrodes (GE) producer in India and fifth largest globally, with an installed capacity of 80,000 MTPA and co-generation power capacity of 77 MW at the worlds’ largest single location integrated graphite electrode manufacturing facility near Bhopal (MP). GE is essential for making steel through environment friendly electric arc furnace (EAF) route, using scrap. At current prices, GE comprises ~3% of cost of producing steel through EAF route. Needle Coke (NC) is the key raw material to produce Ultra High Power (UHP) grade GE; a MT used to produce a MT of GE. NC finds application in the growing Lithium Batteries industry also, but viable only at low prices, ensuring availability of NC for the GE industry. Calcined Petroleum Coke (CPC) is the key raw material to produce Non-UHP grade GE.

Investment Rationale

Global industry consolidation/capacity closures (CY13-CY16) and environmental clamp down in China; brought an unprecedented boom in GE industry during FY18 and FY19

* In April 2017, environmental concerns made China shut down its polluting ~200 mn MTPA induction furnace steel capacity. To fill this global space, erstwhile closed or underutilised EAF capacity returned, resulting in EAF’s rising share in global steel production (now ~47% exChina) generating additional GE demand. Simultaneously, China also closed some of its polluting GE units. Meanwhile, Global (ex-China) GE demand rose to ~700,000 MTPA, matching the post-consolidation global GE capacity of ~784,000 MTPA (at normal ~90% CU). The shortage made UHP GE (even the normally cheaper non UHP GE) prices rise from ~$2,350/MT in March’17 to over $15,000/MT during CY18. Meanwhile, the three NC producers globally also raised NC prices from ~$500/MT in FY17 to over $4,000/MT in FY19. Sensing acute shortage, GE players stocked up NC even at high prices.

GE prices moderated drastically during FY20 and FY21

* Global slowdown led to moderation in demand for steel and steel prices, negatively affecting demand for GE. New non-UHP GE capacity in China became surplus and was dumped in global markets, including India (after removal of Anti Dumping Duty on Chinese GE by GoI), bringing down GE prices substantially. US sanctions on Iran, a significant ~8-10% market for Indian GE players, further affected them. Meanwhile, during the rapid run up of GE prices, for optimal benefits, both global EAF and GE producers, had stocked up UHP GE inventory.

* These headwinds, accentuated by COVID-19 pandemic, led to moderation of GE prices from a high of over $15,000/MT, to below $4,000/MT for UHP GE (~70% of HEG’s produce) and nonUHP GE below $2,000/MT, bringing down margins substantially, but reducing volume of dumping from China to a trickle. GE players, globally, also took production cuts in UHP GE for de-stocking.

* NC prices also moderated sharply from ~$4,000/MT to below $1,500/MT. Domestic CPC price, key raw material for non-UHP GE, also came down from ~Rs 200,000/MT to ~Rs 40,000/MT

GE prices on uptrend; Conditions getting set for the next up-cycle..

* Destocking of high-cost NC and GE down the value chain completed in CY21.

* Due to capacity closures/rationalisation during CY20, global GE capacity further reduced to ~7,37,000 MTPA. No greenfield GE or NC capacity is likely to come up globally, in the near future.

* As per S&P Platts, in 2021, China has approved the construction of 43 new EAFs with a total steel capacity of 29 mn MTPA through capacity swaps (~10 mn MTPA in 2020).

* China abolished a rebate of 13% VAT on certain steel exports to reduce steel production and exports. China's steel exports are expected to fall further, under a Government policy to cut or maintain crude steel output at 2021 levels. This policy is in line with Beijing's goal to achieve carbon neutrality by 2060, resulting in lower steel exports from China.

* Steel producers in rest of the world, increased production to fill the resultant supply gap. Since ~47% of steel produced ex-China is via EAF route, GE demand will rise.

* In USA, ~20 mn MTPA of steel capacity through EAF route is expected to come on stream in phases from 2023 onwards. Further, Europe is replacing its existing ~16 mn MTPA Blast Furnace capacity with EAF, which is expected to be operational by 2025. Thus, ~36 mn MTPA of new EAF capacity will create additional demand of ~50,000 MTPA of GE.

* Both, Global and Indian GE players have increased selling price of GE to be delivered during Q2CY22 by ~6-8% on top of a similar price hike in ~Q1CY22. Going forward, industry is optimistic of further price hikes. However, NC prices is also witnessing an up-move.

* The impact of these developments is already visible from Q1FY22 results. It appears that green shoots of the next GE up-cycle are round the corner and the stage is being set for a higher new normal for the GE industry. Medium to long term prospects look optimistic.

Stable quarter led by better realisation

* During Q4FY22, HEG’s CU improved from recent low of ~50% in Q1FY21 to ~90% in Q4FY22 (H2FY22 CU was also 90%). Average GE (UHP and Non UHP mix) sales realisation improved to ~$4,900/MT during Q3FY22 as compared to ~$4,500/MT during Q3FY22.

* During Q4FY22 & FY22, HEG accounted Rs 191.2 mn and Rs 306.5 mn respectively on CSR spend under “Other Expenses”. During Q3FY22, the Company has settled an old power due of ~Rs 150 mn, accounted under “Power & Fuel” cost.

* HEG is expanding its GE capacity by 20,000 MTPA with an investment of ~Rs 12 bn, at its existing facility, slightly delayed by the pandemic and expected to be operational by end-FY23.  The Company has announced a dividend of Rs 40/share for FY22.

Valuation

The recovery of GE demand globally, has led to improvement in realisation and we remain cautiously optimistic on demand momentum trend, provided the Chinese policy on the environment remains as stated above. We have valued the stock at 6x FY24E EV/EBITDA and recommend a ‘BUY’ on the stock with a target price of Rs 2,024 in 18 months (82% upside).

To Read Complete Report & Disclaimer Click Here

Please refer disclaimer at https://www.skpsecurities.com/index.php/Disclaimer_new/disclaimer

SEBI Registration number is NOS : NSE : INB/INF 230707532

Above views are of the author and not of the website kindly read disclaimer