HEG Ltd. Rs. 2435
Truth is elusive. It hides behind the fog of fuzzy data, distorted facts, faulty logic, wrong correlations, personal biases etc. But however tough it may be, it is necessary to form an opinion to the best of one’s ability and be ready to change it in the face of contrary evidence. Investment in commodity stocks requires doing just that albeit about one of the most inscrutable truths – the state of the global economy! So here goes a dive into the facts to form an opinion (whether right or wrong only time will tell) and then choose to act (or not) upon it.
Given below are a few facts and correlations about steel and graphite industry: –
- Graphite electrodes are one of the critical consumables used to manufacture steel via Electric Arc Furnace (EAF) route. EAF is increasingly being preferred for manufacturing steel because it emits 75% less pollution and is also cost effective compared to the conventional manufacturing method. Around 50% of global steel (ex-China) is produced via EAF method. In China, only around 15% steel is produced via EAF.
- Consumption of graphite electrodes therefore depends on increase in steel production via EAF route which in turn depends on growth in global demand for steel. Global steel demand has been almost static from 2019 to 2024 hovering between 1.87 billion metric tons to 1.95 billion metric tons per annum.
- Graphite electrode prices have been on a downward trend since the last few quarters. However, on 9 Sept 2024, Resonac (formerly Showa Denko), the second largest producer of graphite electrodes in the world, announced 20% price hike for all new orders (HEG with 100,000 metric ton capacity is the third largest producer behind market leader GrafTech International with around 230,000 metric ton capacity and Resonac with approx. 210,000 metric ton capacity).
Following is an opinion based on the above facts: –
- Share of steel production through EAF method should rise particularly in China due to decarbonisation efforts. Most of the new steel plants are being set up using this route which would give fillip to demand for graphic electrodes.
- Global steel demand has been sideways since 2019. All commodities go through cycles of ups and downs and steel is no exception. With central banks reducing interest rates across the world, China embarking on stimulus to shore up local demand, hopeful cessation of geopolitical conflicts, there are decent chances of demand revival leading to higher demand for steel and thereby graphite electrodes.
- Resonac, the second largest producer in the world, has hiked prices. This should lead to global pricing improvement and consequential increase in margins. HEG being the third largest producer would be a major gainer.
HEG therefore seems to have reasonable chances of enjoying decent topline growth and margin expansion in coming times. There are also a couple of other positive factors.
HEG has announced foray into graphite anode used in manufacture of lithium-ion batteries which run electric vehicles. It is setting up this plant with an outlay of 1800 cr. This division will be demerged and listed separately which is a sensible step as it will segregate the risk and unlock value. The company has also announced a share split from FV of Rs 10 to Rs 2 which raises liquidity and generally leads to higher stock prices.
Some concerns are not to be overlooked. Manufacturing cost of graphite electrodes is highly dependent on its key raw material needle coke which is made either from crude oil or from coal. At present crude oil and coal prices are stable but any steep hike will put pressure on margins. The latest quarter viz Q1FY25 witnessed sharp decline in HEG’s performance due to lower offtake and margins. Low demand scenario can continue for longer than expected leading to correction in stock prices.
At FY2024 EPS of Rs 80, HEG is trading at PE of 30 which is steep for a commodity player. It needs to double/triple its profits in the next 2-3 years to give adequate return to those entering at current levels. This is achievable if things go as opined. Containment of risk is necessary by choosing the correct position size and consider exiting if the future does not play out as expected.