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.
Global brokerage house Bank of America Merrill Lynch expanded its coverage of graphite electrodes (GE) with four new Buy ratings globally, including HEG and Graphite India as it believes graphite electrode upcycle becomes a structural story now.
Graphite India share price was locked at 5 percent upper circuit and HEG share price rallied as much as 19 percent in morning on Wednesday.
The brokerage house feels the valuations are attractive at current levels due to correction in stocks 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.
BofAML believes HEG and Graphite India offer the purest play on the sector with over 95 percent of their revenue derived from electrodes – the majority exported to global customers.
It feels both stocks trade at the lowest multiples globally and offer the most upside to price objectives (HEG: 119 percent, Graphite: 104 percent).
Also its USD exports are around 70 percent of sales, so they benefit from a weak rupee, the research house said.
HEG fell 24 percent and Graphite India 22 percent from September 2018; hence both are available at discount to its global peers. Both this correction, HEG shot up 2,693 percent and Graphite India jumped 780 percent from June 1, 2016 to August 31, 2018.
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, BofAML said.
Existing plants are at 90 percent plus utilisation and can barely raise output, the brokerage house said, adding high barriers to entry, 2-5 years to build new capacity and limited availability of needle coke means it sees tight conditions and likely higher electrode prices (still only 5-7 percent of EAF costs).
New capacity in China, but their presence in the EAF market is small, while rising competition with EV batteries for needle coke will limit electrode output regardless of capacity adds, it said.
Hence the resultant tightness has already driven a fivefold rise in graphite electrodes 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.
BofAML estimates global industry profit at a record $5.1 billion this year, rising to $5.6 billion in 2019. This compares to just $1.5 billion in 2017 and losses during 2013-15.
Earnings have risen faster than share prices, leaving the sector attractively valued with 1-year forward P/E at just 5.4x, EV/EBITDA at 3.6x and an average dividend yield of 5 percent, it said.Key risks, which highlighted by the research house, are rising needle coke costs, a reversal of Chinese policies and a weaker USD.The Great Diwali Discount!
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