HEG stock rated Buy by Jefferies, says outlook good given demand situation

By: |
Updated: October 28, 2017 2:43:24 AM

We recently hosted the HEG Management in Asia. Key takeaways from investor discussion were

China has cut 100-150 mnt of steel capacity to tackle pollution.

 

We recently hosted the HEG Management in Asia. Key takeaways from investor discussion were –(i) shutdown of induction furnace capacity in China has led to revival in demand for graphite electrode. (ii) closure of graphite electrode capacity in last 4-5 years has led to tight demand and supply situation. (iii) needle coke availability remains a concern. (iv) higher graphite electrode realisation going forward.

Demand-supply to remain tight

China has cut 100-150 mnt of steel capacity to tackle pollution. As per management, these capacity closures will drive steel exports to 60-70 mnt from China in CY17 v/s 109 mnt in CY16. Additionally, China’s billet exports will fall to 7-8 mnt from 30 mnt earlier. This will lead to higher production from the EAF method especially in countries importing from China. Management estimates this has driven incremental electrode demand of 100kt v/s 600kt annual industry demand in the last 2-3 years. With new capacity additions not being discussed and needing at least 2 years to come up, the tight demand-supply situation is likely to continue till FY19E-20E.

Needle coke availability a concern

Management mentioned that 10% of global needle coke production is currently being diverted to lithium ion batteries. HEG has semi-annual contracts for the raw material till March 2018 to operate at 80-85% utilisation in FY18E and is comfortable on contracting similar volume levels for FY19E. We have lowered our FY19E utilisation to 85% from 90% factoring this in.

Graphite electrode prices rising; EPS upgrade 75% for FY19E

HEG has been able to renegotiate some of the old contracts to current spot prices. For FY19E, it plans to get into yearly contract for electrode volumes but quarterly on pricing. We raise our graphite electrode price assumptions to $6k/ton vs. `$5k/ton previously for FY19E and $6.5k/ton vs. $5.2k/ton previously for FY20E.

Valuation/risks

We maintain Buy with revised TP of Rs 1,753 (39% upside) valuing HEG at 7x EV/Ebitda FY19e —12% discount to historical mean. Risk: Decline in graphite electrode prices.

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Next Stories
1Petrol, diesel prices to rise sharply? Crude oil rallies just below $60 a barrel, highest since mid-2015
2No divergence reported in ICICI Bank NPAs as RBI audit still incomplete: Chanda Kochhar
3Hong Kong’s iconic trading floor is latest to close for good