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