India Ratings downgrades HEG to A+, outlook stable

Company hit by high input costs and forex losses, posted a steep fall in operating margins in FY12

India Ratings has downgraded the long-term rating for HEG Ltd, the graphite electrode unit of LNJ Bhilwara Group, to ‘A+’ from ‘AA-’ on deterioration in its credit profile. High input costs and foreign exchange losses have hit the firm. HEG posted a fall in operating margins to 10.5 per cent for 2011-12 from 20 per cent a year ago.

However, margins improved to 14 per cent in April-December 2012, India Ratings said in a statement.

Its leverage, reflecting net debt to operating margins, rose to 8.5 times last financial year from 4.1 times in 2010-11. It, however, improved to 6.4 times during the nine months ended December 2012.

Ratings are constrained by HEG’s highly working capital intensive nature of business. The net cash conversion cycle has remained above 300 days since FY09, though improved to 321 days in FY12 (FY11: 361 days). The long working capital cycle stems from a long production cycle, which is an industry-wide phenomenon.

Growth in the graphite electrode (GE) industry depends on growth in steel production through the electric arc furnace (EAF). The EAF forms about 29 per cent (at the end of December 2012) of total global steel production.

GE is a consumable component for the EAF route, which results in continuous demand for the product. The slowdown in the western world could result in muted revenue growth for the GE industry in the short to medium term, given that Europe and America contribute bulk (FY12: 33 per cent) to HEG’s revenue.

HEG is one of the leading GE manufacturers with its diversified customer base. It is 100 per cent self-sufficient in power with use of captive power plants. The entry barriers in terms of capital and technology remain high, giving an edge to the existing GE players.

The company also remains exposed to fluctuations in foreign currency, as bulk of its revenue (FY12: 70 per cent) is contributed by exports. Though, some amount of natural hedge is also there due to the import of key raw material. HEG incurred a foreign exchange (forex) loss of Rs 92.85 crore in FY12 and Rs 57.7 crore in April-December 2012.

Forex losses associated with operations (imports and exports) are not high as the company is a net earner of foreign exchange. However, during 2011-12, HEG made forward sales of dollars expecting the rupee to appreciate against major currencies. But the rupee depreciated further resulting in exceptional forex losses of Rs 35.5 crore in the third quarter, Rs 48.2 crore in the fourth quarter of FY12 and Rs 48.4 crore in the first quarter of FY13.

Now, the company has started managing its net foreign exchange exposure on a month-to-month basis.