HEG has seen a significant rise in profitability over the last 12 months as graphite electrode (GE) prices have risen fivefold
HEG share price rallied as much as 20 percent in morning on Wednesday after global brokerage house Bank of America Merrill Lynch initiated coverage on the stock with a Buy rating and target price of Rs 6,700, implying upside potential of 110 percent.
The stock price was quoting at Rs 3,840, up Rs 614.10, or 19.04 percent on the BSE, at 09:35 hours IST.
The brokerage house feels the valuations are attractive at current levels due to correction in the stock following weak market sentiment for more than a month now, and also the demand for graphite electrode will continue to be strong globally due to Chinese curbs on pollution and steel output.
"The stock is trading at 3.8x P/E and 2.0x EV/EBITDA on FY20E – well below peers in Japan and China. We attribute this to the current weakness of Indian equities and investors' lack of conviction in the extent and longevity of the cycle. The price target is set at average prior cycle peak earnings/trough level multiples of 7.5x P/E and 5.2x EV/EBITDA for FY20E," BofAML said.
HEG fell 24 percent from September 2018; hence it is available at discount to its global peers. Before this correction, it rallied 2,693 percent during June 1, 2016 to August 31, 2018.
BofAML said graphite electrodes (GE) are key consumables used in Electric Arc Furnace (EAF) steel production. Chinese curbs on pollution and steel output look set to put EAF on a path of structural growth, while rising competition for needle coke from EV batteries limits production.
The resultant tightness has already driven a fivefold rise in GE prices, said the research house which sees record levels of profitability sustaining. "Valuations are attractive as the market seems yet to have cognized the story."
China's new policies, introduced in late-2016, mark the beginning of a possible 20-year demand upcycle for electrodes as cleaner EAFs start to replace blast furnaces. EAF was only 6 percent of China steel output in 2016 versus 46 percent in the rest of the world – implying substantial potential upside.
Fewer Chinese exports have also lifted global steel prices – increasing EAF output globally. After growing at 7 percent per annum during 2017-18, BofAML forecasts global sustained electrode demand growth of 3 percent per annum going forward, 5 percent per annum in China.
Along with an upside potential of 110 percent in the stock, the research house also expects the company to maintain its 30-40 percent payout ratio implying an 8.5 percent dividend yield. "Investing in related industries is possible, but it sees limited options and instead look for further potential shareholder payouts."
HEG has seen a significant rise in profitability over the last 12 months as graphite electrode (GE) prices have risen fivefold. Chinese limits on steel production and efforts to cut pollution are lifting steel output by Electric Arc Furnaces (EAF).
High entry barriers and limited needle coke supplies mean BofAML sees capacity staying tight and a multi-year period of high prices and profit. "With 99 percent of revenue from electrodes, 2/3 as exports, HEG is the purest play on the global sector."
The research firm expects company's net income at a record Rs 3,130 crore this year – up from Rs 1,100 crore in FY18. Q1FY19 net income was Rs 770 crore (24.6 percent of FY19 forecast) versus a Rs 7.7 crore loss a year ago.
Graphite electrode prices are remaining firm, said the research house which sees the company capable of passing on rising needle coke costs.
Further upside is possible as the company lifted utilisation of its plant and benefits from a weak INR, it believes.
BofAML said debt free and generating operating cash flow of Rs 1,600-3,300 crore per annum, HEG's balance sheet is strengthening rapidly with net cash/book equity seen reaching 50 percent by FY21E.
HEG has announced its intention to expand its plant (already the world's largest outside China) from 80,000 tonne per annum to 1,00,000 for a maximum Rs 700 crore.
Risks which highlighted by brokerage house are an easing of China’s anti-pollution efforts, faster capacity additions and a weaker USD.Graphite India was also locked in 5 percent upper circuit at Rs 829.20 and there were pending buy orders of 52,781 shares, with no sellers available.