Anubhav Sahu Moneycontrol research
HEG is all set to implement a Rs 750 crore buyback plan (announced on November 26) in due course. Given the premium, this provides a decent opportunity to investors looking for a partial exit. However, for long-term investors, business fundamentals in terms of supply-demand dynamics remain intact and that’s what prompted the management to go for an expansion plan (Rs 1,200 crore for 20,000 tonne).
Pls also read: Higher FY19 capacity utilisation guidance a positive
Buyback price at an attractive premium; lower acceptance ratio implied
HEG’s plan includes a proposal to buyback 1,363,636 shares (3.41 percent of paid-up capital). Company’s decision is based on the premise that the payout ratio of 34-35 percent should be maintained for which a mix of dividend and share buyback plan is pursued. Buyback price of Rs 5,500 is at 41 percent premium to the prevailing market price. However, it’s noteworthy that promoters are participating in the buyback. Further, based on current holdings of the retail participants (4,491,393 shares; 11.2 percent share) acceptance ratio is expected to be low.
Higher capacity utilisation and expansion on cards
Board has also approved a plan to increase the capacity of HEG from 80,000 to 100,000 tonne during the course of 2.5 years. Expansion plan would be funded through internal accruals given the strong balance sheet. New capacity would add about ~3 percent of the global capacity of graphite electrodes (700,000 tonne) and hence, would hardly impact the supply-demand dynamics adversely.
In the near term, higher capacity utilisation is expected. Management recently updated about improved availability of needle coke in the second half of FY19. It is mainly because of capacity debottlenecking (50,000-60,000 tonnes) by Conoco Phillips, on account of which HEG expects ~90 percent capacity utilisation in H2. In the long term, however, the company’s tentative plan for a 25 percent increase in graphite electrode capacity depends on the availability of new supply of needle coke in future.
Management is hopeful of further improvement in product prices in the new contract cycle (January - March CY20 quarter), for which contracts would be signed in the next 4-5 weeks.
China opportunity
HEG management updated that China’s share in the global EAF based production of steel may rise from current 10-12 percent (6 percent in 2016) to 21 percent in 2022. This would mean additional demand of graphite electrode of the order of 310,000 tonne (compared to 2016) is expected in China. This as well means that companies like HEG and Graphite India can participate in China opportunity as new electrode capacities in China would take a longer time to come up than steel capacity.
Chart: Global EAF (Electric Arc Furnace)-based production
Source: HEG
Going forward
We remain constructive on the stock (4.3x FY20e) given the end market tailwinds, preference for EAF route for steel manufacturing and China’s supply-side reforms. In the short term, additional earnings accretion comes on account of the improved availability of needle coke. For the longer term, given the long gestation period for the greenfield projects, cash flow visibility expected to remain robust.
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