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Our Take
HEG reported a topline of Rs. 1,587 crores in Q1 FY19 against our estimate of Rs. 1,645 coroes and against Rs. 1292.45 crores in Q4 FY18 on account of increasing realisation at $14,125 per metric ton assuming USD/INR rate of Rs. 68.50 for the quarter. EBITDA in Q1 FY19 stood at Rs. 1,188 crores against our estimate of Rs. 1,231 cores and against Rs. 951 crores in Q4 FY18. Whereas, PAT arrived at Rs. 770 crores against our estimate of Rs. 801 crores in Q1 FY19 and against Rs. 634 crores in Q4 FY18. At fair case assumptions HEG Trades at 5.5x P/E & 3.6x EV/EBIDTA which is below global peers. With a 50 crore cash generation each week, no debt, brownfield expansion led by minimal CAPEX using internal accruals, possibility of establishment of new business verticals there are more than enough reasons to aid expansion of valuation. We recommend to ADD this stock expecting an FY19E EPS of Rs. 788 and assign a P/E Multiple of 7x FY19 thus arriving at a target of Rs. 5519.
1. Reconfirming Macros:
Chinese govt. is taking anti-pollution measures more seriously and a new action plan has been released to expand the air pollution control to 82 cities. It aims at shutting down traditional pollution causing BOF Steel plants to bring capacity under 1 billion TPA BY 2025. A simple calculation of macro environment directs to a GE deficit of about 140000 tons by 2020 as expected Chinese EAF capacity growth to 160mMT would mean a requirement of 860000MT of GE requirement, where as the current GE capacity Ex-China is 725000 MT. Even if some expansion by existing players takes place a possibility of this deficit totally being avoided seems bleak.
2. Graphite Electrode Pricing
Realizations for graphite electrode clocked $14,124 per MT in line with our expectation of $14,000 in Q1 FY19 and against $11,800 per MT in Q4 FY18 mainly on account of no presence of legacy contracts at lower prices. Graftech (US graphite electrode producer) in their recent con call rephrased their outlook on GE pricing from $17,000 - $23,000 to $15,000 - $20,000. However this is not bothersome, HEG has taken a price hike in the month of July, 2018 reiterating our assumptions of better realizations in the coming quarters. Exports for the quarter were at 65% against 79% in Q4 FY18.
3. Utilization, Debt & Cash generation
Capacity utilization level was 82% in Q1 FY19 vs 84% in Q4 FY18 however, management is confident of reaching utilization levels of high 80’s in FY19. Finance cost for the quarter came in lower at Rs. 1.79 crores and is expected to remain the same going forward as the company has no debt. Cash on books at the end of Q1 FY19 stood at Rs. 400 crores. As of 6th August, 2018 HEG has ~ Rs. 500 crores in treasury and is adding around ~ Rs. 50 crores every week which would be employed at a risk free rate or would find another business venture application as per management discretion.
4. Needle Coke
Needle coke pricing in Q1 FY19 came in at ~ $1,500 per MT in line with our estimates, these lower prices were on account of inventory held with HEG at old prices. Increase in needle coke prices comes with a lag of ~ 5 – 6 months (2 months of shipment time, 2 ½ months of conversion time to GE and 1 month of inventory). Even though the needle coke prices are in the range of $3,000 - $3,500 in the month of July, 2019 cost per ton of needle coke is expected to be ~ $2,100 in Q2 FY19 as HEG still holds some needle coke at older prices. An effect of complete price hike will only be seen in H2 FY19.
5. Future Outlook
- Increase in capacity utilization levels from current levels of 82% to ~87-88% on annual basis.
- Price hike resulting in increasing realization in the coming quarters due to continuing robust demand.
- Interest income earnings from cash flow generation going forward.
- Brownfield capacity expansion plans from 80,000 MT to 100,000 MT in next 18 – 24 months for which management has guided a cost of ~ Rs. 40 – 50 crores.
- Free cash generated would possibly be employed to add another vertical of business as per management’s discretion
` 6. Outlook and Valuation
At fair case assumptions HEG Trades at 5.5x P/E & 3.6x EV/EBIDTA which is below global peers. With a 50 crore cash generation each week, no debt, brownfield expansion led by minimal CAPEX using internal accruals, possibility of establishment of new business verticals there are more than enough reasons to aid expansion of valuation. We recommend to ADD this stock expecting an FY19E EPS of Rs. 788 and assign a P/E Multiple of 7x FY19 thus arriving at a target of 5519.
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