HEG: Crude reality

The buyback should provide some support for the stock but high oil prices are a concern

The huge underperformance of the HEG stock, since the start of year, is possibly what has prompted the management to buy back its shares. Since the start of 2008, HEG has lost 152 per cent compared with a fall of around 30 per cent for the Sensex.

Shares will be bought back at a maximum price of Rs 350 per share, a premium of 44 per cent to the current stock price and a sum of up to Rs 48.50 crore has been allocated for this.

That should not hurt the balance sheet given that the Rs 946 crore company reduced its debt-equity ratio to 1.3 in FY08 from 2.5 in the previous year. At the end of March 2008, its net worth was Rs 533 crore. Also, in August 2007, HEG sold its steel business for Rs 122 crore.

That’s why the June 2008 quarter numbers are not really comparable with those of the June 2007 quarter.

Nevertheless, the firm managed to extract better realisations for graphite electrodes –up 30 per cent —-with the result that its operating margins expanded by a smart 1,680 basis points to 37.8 per cent. The firm’s raw material bill should have risen sharply since it is heavily dependent on derivatives of crude oil such as needle coke.

However, the price increase in crude has not affected costs because HEG had entered into contracts to purchase these raw materials at a fixed price. However, revenues for the quarter, at Rs 237 crore, were subdued because of a fall in production of 4 per cent to around 12 kilo tonne electrodes with the plant shut for maintenance for a couple of weeks.

HEG is investing in a brownfield expansion plan, to enhance its capacity to approximately 80 kilo tonnes per annum. This would entail an investment of around Rs193 crore, being funded mainly through internal accruals, and is expected to be completed by the end of FY10.

The stock currently trades at eight times its FY09 estimated earnings; at the buyback price of Rs 350, it would trade at 11.6 times. Given that crude prices remain high, the company could face cost pressures going ahead.