HEG vs Graphite India. What is in store for these companies for 2018 ?
HEG and Graphite India, both these stocks gave multi-fold return last year. Lets see whats in store for the investors of these companies for the year 2018.
I am sure most of you must have heard of the Graphite Electrode(GE) story. I would like to add some comparison between the two graphite electrode company in India i.e. HEG and Graphite India.
You can look at my earlier blog to understand the story better.
Both these company came up with the Q4FY18 result last week and the GE story is getting stronger day by day. HEG which lagged Graphite India(GI) during most part of its existence has started to lead its peer since 2nd Quarter 2018. Since then HEG has been widening the gap with GI & Gap being the largest in the latest quarter.
Even then, both the company generated an EBITDA of over 50% in Q4 FY18 which in itself is something out of the ordinary.
I would like to add a few more points to help you better understand the story.
Given the highly technical nature of the product & the raw material, there are only 6-7 GE manufacturers in the World & only 3 needle coke manufacturers. Not only Graphite electrode, needle coke(Key raw material for Graphite Electrode) also has been in a tight supply restricting these Graphite electrode manufacturers to expand capacity.
Coming back to our original story of HEG beating Graphite India(the larger player), we need to know WHY? What has been the factor for such a turnaround? As mentioned in my earlier blog, there are the 3 key factors.
A supply-side constraint of GE due to pollution crackdown by the Chinese govt over the past few years: Prices have gone up several times since 2016 end
Spike in prices of key raw material used in manufacturing GE: Prices have gone up several times since 2016 end
All time high steel prices further increasing the demand of GE
Now, both being in the same industry and capacity of Graphite India being higher than HEG, why would HEG lead Graphite India?
The answer lies in ‘Proactive management’. You need to understand that B2B manufacturing happens on predefined rates that may be monthly, quarterly, annually(Depends on the sector). And during that period if there are any changes in the price of the end product or fluctuations in the raw material cost, everything has to be carried out at the predetermined rates only.
Here, the top management of HEG was very quick to gauge the changing trend & opportunity and take full advantage of it. As soon as HEG’s management saw the prices of Graphite electrode & Needle coke surging, they stopped taking new orders at old rates. This would imply the better pricing for the end products and hence better margins. Given the supply constraint in the industry, the buyers have no other option but to agree.
Also, would like to add one more point that since both the company are manufacturing at almost full capacity(to the extent they can procure needle coke), the growth in the sales & profit is value driven & not volume driven. The production constrained by capacity didn’t grow much but the prices or value increased significantly.
For the latest quarter, the older or legacy orders contributes 70% of sales for GI and just 22% for HEG. Now, HEG doesn’t have any legacy order for the next quarter i.e. Q1 FY19 whereas, for Graphite India, there are still little less than 5% of legacy order left. Also, Graphite India have greater capacity than HEG, Graphite India will be able to surpass HEG in terms of Sales growth in the next 1-2 quarters, but it needs to be seen if could how long does it take to beat HEG in terms of profitability.
Let us look at FY18 performance:
Since Graphite India was stuck mostly with legacy orders, the realization per tonne was low for Graphite India for the last fiscal.
Graphite Electrode prices have kept its uptrend and is currently hovering at around $17000-$23000(More than double of the last year realized prices). Even if I take a conservative approximate on how much will they charge in the next year, I expected the revenue of HEG to cross ₹6000cr in FY19 & Graphite India to cross ₹6500cr.
Given the superior proactiveness and business acumen shown by HEG team off late, I would say HEG has a slight edge.
There are a few judgement of error from my end.
1. The graphite electrode(GE) prices surged due to panic buying i.e. stocking for more than required. So when there is stocking, there is expected to be destocking. When destocking happens, sales will go down, product prices falls.
2. When there is abnormal increase in prices of any product, increased profitability brings in lot of competition. Leading to drop in prices. One can never underestimate China in any aspect. They were quick to restart facilities.
3. HEG cut short or cancelled previous contracts. In the very short term it might look attractive but it damages client relationship which takes years to build.
4. HEG announced buyback with the promoter participating in that. That is itself implying promoters want to make money for themselves.
5. Irrational promoter salary of HEG was also a red flag.
6. Unnecessarily buying stake in related companies to benefit themselves.
7. Steel prices were at an elevated levels, encouraging steel companies to be lenient while buying GE as it just 3-4% of total cost. When the prices are at a high level, it can only go down. So, when the steel prices fell towards end 2018 by 30%, these companies reduced production and started renegotiating GE prices.
8. Removal of Anti dumping duty enabled Chinese companies to export to India. It led to sharp blow on the GE prices. It mainly hit high power GE prices, damaging the most as China mainly produces high power GE and lacks capability of Ultra high power GE.
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