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Investment Guru India 2018-05-16 14:04:59

Graphite India Limited (GIL), incorporated in 1974, is promoted by Mr K K Bangur of Kolkata, is the largest graphite electrodes (GE) producer in India and third largest globally, with an installed capacity of 98,000 mtpa and co-generation power capacity of 33 MW (19.5 MW hydel capacity & 13.5 MW multi-fuel routes) spread over four locations viz. Durgapur (W.B.), Bangalore (Karnataka), Nasik (Maharashtra) and Nurnberg (Germany). GE is essential for making steel through electric arc furnace (EAF) route.

Investment Rationale

Global industry consolidation/capacity closures, environmental clamp down in China and rise of EAFs rapidly reversing demand-supply equilibrium, creates an unprecedented windfall and structurally taking graphite electrodes industry into a sustainable higher orbit of profitability

* Global GE capacity was ~900,000 MTPA (ex-China) while demand was only ~600,000 MTPA. In recent years, global industry consolidation led capacity rationalisation and muted GE prices led to closure of ~190,000 MTPA GE capacity, reducing global capacity to ~700,000 MTPA (ex-China).

* Environmental clampdown on China’s polluting GE units has not only resulted in withdrawal of whatever low grade GE China was selling in global markets, it has also created additional global demand for GE to serve Chinese markets.

* China also enforced shut down of its polluting and inefficient ~140 mn MTPA induction furnace based steel capacity. To use its steel scrap, this capacity is now getting gradually replaced. ~50 mn MTPA EAF capacity to suit China’s low grade GE, is likely to be added over next few years. This will consume China’s current and upcoming GE capacity. In any case, Chinese GE competes only marginally in global markets.

* EAF’s share in global steel production is rising, generating sustainable demand for GE.

* Out of total GE capacity of ~160,000 MTPA in India, Indian steel makers consume 60,000-65,000 MTPA, which they procure at lower prices than international markets.

Unprecedented, yet sustainable spike in GE prices, driving GIL

* Due to above developments, GE producers have gained unprecedented pricing power. GE prices have moved up from ~$2,350/MT in March’17 to over $15,000/MT now. We believe, this is a major structural, sustainable boom till at least FY20, if not beyond. Revival of global steel industry provides a tail wind.

* PE fund owned industry major Graftech, has locked in 60-65% of its capacity for three to five-year take-or-pay contracts at ~$9,500-$10,000/mt, seemingly in its bid to raise its valuation and give an exit to its shareholders. Recently it has stated selling at over $16,000 MTPA in spot market, giving us confidence that GE prices will remain strong in the medium term.

* Meanwhile, the three Needle Coke producers in the world have also started raising prices and reducing the tenure of their contracts from a year to a quarter or two. Their pricing power has lately increased due to Needle Coke finding its application in the growing Lithium Batteries industry in China. Currently in the range of $2,500- $3,500/MT, we assume it can move to $3500-$4500 range going forward.

Strong quarter; CU and operational efficiencies to improve from current levels

* Since GE prices are contracted a year in advance, GIL has probably delivered last bit of legacy orders during Q4FY18 and reported net sales of Rs 12,122.2 mn, registering growth of ~224.7% y-o-y basis due to higher CU & better realisations. Going forward, we expect GIL to enjoy full blown benefit of higher GE prices with average sales realisation upwards of $14,000 MTPA over FY19-FY20. GIL has higher presence in domestic markets realisations are lower in domestic markets vis-a-vis export markets.

* Management has given guidance of better CU to 90%+ levels during FY19.

* During Q4FY18, GIL EBIDTA margin was 55.2%. We expect EBIDTA margins to moderate to ~50% during FY19 & FY20, factoring higher Needle Coke prices.

* As on March 2018, total net cash on GIL books stands at Rs 991 crores. It has also paid a Final Dividend of Rs.12/- per share making it a total of Rs. 17 per share for FY18.

Valuation

GIL is well positioned to capitalize on the positive structural changes witnessed by the GE industry, leading to a sustainable boom, at least till FY20. We have valued the stock on the basis EV/EBITDA of 5x FY20E EBITDA, reducing it from 6x in previous quarter, pending clarity on industry prospects beyond FY20 and effective use of surplus cash generated and recommend a BUY on the stock with a target price of Rs 1,220/- (~63% upside) in 18 months.

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