As cash inflow rises, graphite makers in India face the problem of plenty

Two relatively small firms - HEG and Graphite India - together make a profit of Rs 17 bn in Q1, more than L&T

Ravi Jhunjhunwala, chairman and managing director of graphite electrode-maker HEG, has never seen such large cash entering the company’s coffers in four decades. HEG earned Rs 7.7 billion in profit for the quarter ended June 2018, compared with a profit of Rs 10.81 billion in the entire FY18. The profit translates into a supernormal Ebitda (earnings before interest, taxes, depreciation, and amortisation) margin of 75 per cent. 

The Rs 7.7-billion quarterly profit, on a revenue of just Rs 15.95 billion, is higher than what some of the top Indian firms in sectors such as cement, steel, and paints do. Cement maker UltraTech, for instance, had a profit of Rs 6.31 billion in the last quarter. Asian Paints made a profit of Rs 5.71 billion and steel maker SAIL earned Rs 5.4 billion. 

Graphite electrode is an input for steel producers using electric arc furnace route (EAF) (against the conventional blast furnace process). The EAF offers flexibility in operations and is low on energy consumption and pollution. “This is a highly unusual situation. We have never seen such a phase. People ask me for how long this is going to last,” Jhunjhunwala, also the chairman of LNJ Bhilwara Group, told Business Standard. 

The rapid surge in cash flows turned HEG into a debt-free company this March after it retired a debt of Rs 8 billion. The firm is still sitting on a cash of Rs 5.5 billion as of June 30 and it continues to surge. “When I meet well-wishers, I can envision the thought of running in their mind — what will HEG do with the unprecedented volume of cash,” Jhunjhunwala said. 

The BSE-listed HEG’s stock price has seen a ninefold jump in the past year and stood at Rs 4,189, giving the firm a market capitalisation of Rs 167 billion and taking the value of promoters’ holding to Rs 102 billion as of Tuesday. 

Analysts still see an upside. Jefferies gave a ‘buy’ recommendation on the stock early this month with a target price of Rs 5,430. “We have raised our electrode realisation for FY19 to $14,500 a tonne from $12,500,” the equity research firm said. It pegs HEG’s gross profit on every tonne of sale at $12,105 during Q1 against a mere $969 profit in the corresponding quarter of previous year.

About two-thirds of HEG’s revenue comes from exports and a depreciated rupee is an edge. Besides HEG, the only second Indian company in this space is the Kolkata-headquartered Graphite India. The K K Bangur-run firm scores over HEG in profits as it has a bigger capacity. It earned a Rs 9.57 billion profit in Q1 on sales of Rs 19.65 billion. The profit is 3,090 per cent, higher than comparable quarter’s number of Rs 300 million in FY18. The company now has Rs 15.23 billion in cash (net of Rs 2.18 billion debt). Jefferies has a ‘buy’ on this share as well with a target of Rs 1,415 though it has rallied almost 400 per cent in last one year to Rs 1, 098. Promoters’ stake is now worth Rs 140 billion in the total market cap of Rs 214 billion as of Tuesday. 

The turnaround in graphite electrode industry has come on the back of multiple factors. In 2017, China cracked down on the polluting blast furnace steel makers, leading to a fall in exports and a global shortfall in steel supply, estimated at 50-60 million tonnes. This steel is now made outside China and around half of them are through the EAF route, which pushed up demand for graphite electrode. 

“An additional 30,000-35,000 tonnes of electrode is required to manufacture 30-35 million tonnes of steel. That took the total electrode demand to 700,000 tonnes, which is similar to the global electrode capacity,” said Jhunjhunwala. But the challenge is that electrode plants cannot run at 100 per cent capacity and therefore there is a shortage. 

HEG anticipates the demand for electrode will grow by 2-3 per cent every year if not more with some increase in steel output. “Where will this supply come from?” asked Jhunjhunwala, whose firm has a capacity of 80,000 tonnes. Globally, only six players are engaged in graphite electrode production with a capacity of some size. He said there was a technology barrier in setting up graphite electrode manufacturing and any new player has to collaborate with one of the existing manufacturers to access the technology. That is why no new graphite unit has been set up in the last four decades after the HEG factory. 

But for the existing players, too, setting up a greenfield unit will take five-six years. Besides the technology, there is a limited supply of needle coke, a key raw material in electrode production. Needle coke is manufactured by three international firms. 

“These needle coke players are not able to get a visibility of demand after five-six years and this is preventing them from investment,” said Jhunjhunwala, who wants to debottleneck the Mandideep unit near Bhopal to take production to 100,000 tonnes. Graphite India has a capacity to make 98,000 tonnes, giving the two Indian companies a capacity of 178,000 tonnes, of which the bulk is exported.