November 7, 2017 | PM Securities
HEG’s reported Q2 FY18 earnings surpassed our expectations and registered a PAT of ~Rs. 112.82 Cr. as against loss of 14.1 Cr Rs in Q2FY17. Majority of the sales of graphite electrodes was contracted at the start of this financial year at ~2400$/ton however the blended realization for the current quarter was ~3600$/ton thus indicating sales of some proportion (20-30%) of electrodes at an estimated $8000 - $ 9000 /ton. In the ongoing quarter as per our findings from the steel manufacturers UHP electrodes that HEG manufactures are being priced between $11000 - $15000 which is a huge leap and shall boost HEG’s profitability substantially. Moreover, In the coming quarters the share of sales on spot prices shall keep increasing in proportion to sales at low contracted price and this shall further aid profitability quarter to quarter. With Chinese government being adamant on pollution curtailment, the possibility of re-initiation of Chinese electrode plants also seems bleak & gives a sense of mid-term sustainability of current electrode pricing.
We continue to endorse our previously established view on the stock and opine investors to HOLD.
Earning's call KTA's
Electrode Pricing: As per managements indication FY19 contracts will be settled upward of 7000-8000$/ton which is the most conservative number we have taken in our estimates. This is reassuring that graphite electrode prices are here to stay.
Debt Repayment: Management is planning to completely repay its long term debt of ~240 Cr Rs in a brief period of 3-4 months. However, short term debt will remain at ~400 Cr Rs as a result of working capital requirements due to long production cycle. We can expect the finance cost to descend from 54 Cr Rs in FY 17 to ~26 Cr Rs in FY 19. This would aid the PAT by another 28 Cr Rs in FY 19.
Chinese electrode plants: Although the chances of revival of electrode plants in china are bleak, re-commencement of these plants is not a direct risk to HEG because the Chinese capacities are that of Non-UHP grade electrodes, whereas HEG’s customers are procurers of UHP grade electrodes.
Needle coke pricing: Needle Coke prices have risen substantially in last few quarters due to its new application in lithium ion battery and increasing demand in the graphite electrode market. Needle coke forms a substantial(>50%) part of total raw material costs however due to continuing re-negotiations of contracts for both needle coke and electrode pricing we believe that this risk can be managed, however some time lags in pass-on can be expected. Also, HEG currently has enough needle coke inventory at old prices to suffice production until March 2018.
Cash flow utilization: In this financial year HEG shall be generating a sizeable cash-flow which shall primarily be used for extinguishing all the long term debt on books, Moreover a dividend pay out to the extent of 30% is being envisaged (Translates to an estimated Rs.38 per share).
Capacity Expansion: Provided the market of electrodes continues the way it is now for a reasonably long period of time expansion of capacity from the current 80000 TPA to 100000 TPA is also being considered as per management’s indication. However, as of now there’s no concrete decision taken for the same.
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