Graphite India Good Prospects Ahead Despite Current Headwinds
India’s growing investment in infrastructure and growing anticipation of demand for affordable housing means that steel demand is expected to remain strong in India.
Factors such as graphite electrodes’ favourable electrical properties and their growing popularity among steel producers , a rise in utilisation of steel scrap, increase in demand for graphite electrodes in end-use industries are key growth drivers for the company
Graphite India Limited is a manufacturer of graphite electrodes, steel, glass reinforced plastic (GRP) pipes, tanks, generation of hydel power and graphite equipments . The company operates across three verticals, namely, graphite and carbon segment, steel and others.
The graphite and carbon segment produces graphite electrodes, various carbon and graphite products and including captive power generation units and impervious graphite equipment division. The steel segment produces high speed steel and alloys. The 'others' segment manufactures glass-reinforced pipes and power generating unit for outside sale. The company’s coke division is engaged in producing carbon paste and electrically calcined anthracite paste. The impervious graphite equipment (IGE) division is engaged in turnkey systems, manufacture and supply of impervious graphite heat and mass transfer equipment and design.
Graphite India is a leading manufacturer in the graphite electrode industry and has a capacity of 98,000 tonnes per annum (TPA). The total installed capacity in India is 80,000 TPA of which 54,000 tonnes is in Durgapur and 13,000 tonnes each in Bangalore and Nashik. Graphite India also own a plant in Nuremberg in Germany which has a capacity of 18,000 tonnes.
INDUSTRY
The graphite electrode market was valued at about USD 10 billion in 2017 and expected to grow at 3 per cent CAGR.
Graphite electrodes are used in electric arc furnace (EAF) based steel mills and conduct a current that melts scrap iron and steel and is used in the steel industry. Its primary manufacturers are based in China ,Europe, India, Malaysia and Japan
Players in the steel manufacturing industry are shifting to electric arc furnaces from the blast furnaces due to their low cost of establishment, more production flexibility, faster project (commissioning) time and low CO2 emissions.
China’s steel exports fell to 53.5 million tonnes (MTs) for the period of JanuarySeptember 2018 with the monthly average falling from 6.3 MTs/month to 5.94 MTs/month, down 5.8 per cent YoY. This aided higher production and utilization in other geographies that produce electric arc furnaces (EAF). Due to the rising levels of pollution, the Chinese government had ordered the production cuts on steel mills in 2016, which led to shutting down of 300,000 tonnes of graphite electrode capacity in China. This opened up a substantial part of the graphite electrode market for the domestic players, putting the demand supply dynamics in their favour.
China aims to move towards a more environmentally-friendly steel production and plans to increase the share of EAF steel production to 20% of its total steel production by 2020. It commissioned approximately 70 MT of EAF capacity in 2018. The share of EAF route to steel production stood at approximately 25-30 per cent at the global level.
A slowdown in the GDP growth of many major global economies like the US, China and Europe is expected, which means that steel production across the industry has been impacted. Overall, the global steel production declined 1.3 per cent as against the previous quarter. India’s steel production saw a decline of 0.3 per cent over the previous quarter. The steel prices have seen a correction due to slowing down of the Chinese economy combined with oversupply of Chinese steel in the global market.
Graphite electrode is considered a key component in multiple industries. Therefore, an increase in industrial activities across sectors like manufacturing, mining, construction and trade would be directly proportional to the demand for graphite electrodes.
A ROLLER-COASTER RIDE
The stock of Graphite India Limited has seen a topsy-turvy ride in the markets over the last 2 years. The stock had a meteoric rise from Rs 98 in February 2017 to Rs 1127 in August 2018, generating a return in excess of 11 times to the delight of its investors in a span of only 18 months. However, the stock has since fallen off the cliff, giving up gains in excess of 50 per cent, making a low of Rs 458 in January 2019
Growth Drivers
India’s growing investment in infrastructure and growing anticipation of demand for affordable housing means that steel demand is expected to remain strong in India.
The consolidation in the steel industry on the back of favourable NCLT outcomes is expected to drive higher capacity utilisation for the steel manufacturers, thus expanding scope for further growth.
Factors such as graphite electrodes’ favourable electrical properties and their growing popularity among steel producers , a rise in utilisation of steel scrap, increase in demand for graphite electrodes in end-use industries are key growth drivers for the company.
The rising demand for EAF-based steel, UHP graphite electrodes, progressing graphite electrode projects, preference by steel-based housing structures all augur well for Graphite India.
The company has a flexible capital structure and the management has indicated an interest in pursuing opportunities in the related carbon space which they think will enhance shareholder value.
Challenges
India removed the anti-dumping duty on import of graphite electrodes from China in September 2018 leading to increased competition and non-UHP prices have been falling in the domestic market which affected realizations by 0-3 per cent over the last quarter. UHP prices have been impacted by weakness in steel prices.
On expectations of further price fall, the steel mills are reported to have been destocking their graphite electrode inventory, as against 2018 when they were restocking in panic.
The sanctions imposed on Iran by the US means that there is political pressure on the allies of the US to curb economic activity with Iran. Iran is a key export destination, accounting for combined volumes of 8-10 per cent for Graphite India and its domestic rival HEG.
The rising prices of key raw materials like needle coke by 24 per cent which is required to make graphite electrodes remains a key concern for the industry. The full impact on Graphite India’s margins is expected to be seen in the second half of FY19 due to the inventory lag. Rising raw material prices combined with lower product prices is expected to deliver double whammy for Graphite India
Financial Performance
For the quarter ended December 2018, Graphite India’s net sales came in at Rs 1562 crore, 67 per cent higher than the corresponding quarter last year on a standalone basis. The EBITDA came in at Rs 932 crore, up by 76 per cent as against Rs 530 crore in the corresponding quarter last year. The net profit on a standalone basis stood at Rs 609 crore, up 79 per cent as against Rs 341 crore in the corresponding quarter last year. The capacity utilization stood 86 per cent in Q3FY19. The increase in revenues and profits were driven by higher realizations and volumes.
However, it was a different story on a QoQ basis. The revenue came in at Rs 1562 crore, a drop of 22 per cent from Rs 2008 crore in the previous quarter. The EBITDA/tonne was $9005/tonne, down by 18 per cent QoQ. The net profit came in at Rs 609 crore, a fall of 33 per cent from Rs 912 crore in the previous quarter. The key reasons for this were lower sales volumes due to stoppage of exports to Iran because of the US sanctions, which resulted in build-up of tailor-made inventory, flat realisations as quarterly contracts were rolled over at similar prices in the quarter ended December over the quarter ended September 2018 and a rise in needle coke costs to $3300/ tonne in 3QFY19 vs $1000/tonne in 2QFY19.
The needle coke contracts have been settled at $ 4500/tonne for 1HCY19 vs $1000/tonne for 2HCY18, which is expected to hit margins over the next few quarters. However, EBITDA margins are expected to be still in excess of 40 per cent as the graphite electrode market is not expected to return to surplus.
Valuation
Graphite India has market capitalization of Rs 8518 crore and trades at standalone (TTM) PE of 3.34x, which is significantly lower than the industry average of 9.83x. The company’s TTM EPS stands at Rs 144.98. The company’s dividend yield stood at 3.90%. The stock has a book value of Rs 240.41. Its price-to-book value multiple stood at 2.01x. The company’s net debt-to-equity stood at 7.9x
The rising prices of key raw materials like needle coke by 24 per cent which is required to make graphite electrodes remains a key concern for the industry. The full impact on Graphite India’s margins is expected to be seen in the second half of FY19 due to the inventory lag. Rising raw material prices combined with lower product prices is expected to deliver double whammy for Graphite India
Conclusion
The graphite electrode industry continues to be under pressure on the back of Chinese players entering the graphite electrode market, Iran sanctions, weak global steel prices and rising raw material prices. However, the management has stated its commitment towards operational excellence and implementation of effective financial controls with the aim to drive sustainable cash flows and further strengthen the balance sheet. Despite a subdued quarter, the prospects of the steel industry continue to remain positive on the back of increased infrastructure spending and expected demand for affordable housing. By virtue of the above factors, we recommend our reader-investors to HOLD the stock