- The business of making graphite electrodes has heavy entry barriers, as the technology involved is a closely guarded secret.
- Weak global offtake kept HEG's capacity utilisation at 75% in FY23, and Jefferies expects it to fall further.
- The stock has rallied 29% in the past month and 54% in the past six months.
As the pressure to decarbonise builds globally, the steel industry – which accounts for 7% of world’s carbon dioxide (CO2) emissions – is on a greener path. As a player in this niche business, the small-cap stock HEG is topping the mutual fund buying charts.
In the last one year, it has given 73% returns on the bourses. However, going ahead, analyst views are divided on its growth prospects.
Better than China
What works in HEG’s favour is that it’s in a niche business with heavy entry barriers thanks to the technology involved, which is a closely guarded secret. So far, only seven companies in the world manufacture these electrodes, and in terms of capacity, HEG ranks number three in the world behind Japan’s Showa Denko and US’ GrafTech, as per InCred Equities.
Moreover, it’s one of the few businesses where Indian companies like HEG and Graphite India can compete with China, and win. “Chinese players have been trying to replicate on the quality front, but to no avail. They still lag significantly behind global players, as a result of which companies like HEG can command a premium over their Chinese counterparts,” said a research report by InCred Equities.
HEG is also moving fast to achieve dominance in this sector by expanding capacity. Its new plant is set to commission by June this year, and of the total capex of ₹1,200 crore, ₹1,000 crore has been spent, as per an update by Jefferies.
Going ahead, this might give it an edge as none of its global peers have added any capacity in the last ten years.
Where is the demand?
Even with all the growth levers in place and the high confidence reposed in the company by investors, many analysts believe that the promise it holds is yet to play out fully. The company gets around 30% of its business from India, and the rest from overseas. The global economic and geopolitical situation has translated to some immediate worry for the sector as a whole as in the financial year gone by (FY23), the global steel production dipped by 4-5%.
“Weak global offtake impacted HEG's capacity utilisation to 75% in FY23. Electrode pricing has also declined by around 3% quarter-on-quarter in Q4. Industry channel inventory is estimated to be higher than normal currently,” says Jefferies.
The orderbook for the product in the US – one of its biggest clients – has remained constant for the last one year. However, the worry comes from closer quarters. China, which produces half of the world’s steel, is also seeing muted demand hurt by a bleak outlook from its real estate sector.
Brokerage outlook
The HEG stock has rallied 29% in the past month and if one zooms out a bit further, it has shot up 54% in the past six, which is when its bounce back started.
Jefferies foresees demand headwinds will continue in this financial year which in turn could see HEG’s capacity utilisation decline further to 65%. So, even though it believes that decarbonisation remains a medium-term structural tailwind, the brokerage has cut its earnings estimates for the foreseeable future (FY23-26), and revised its target price downwards to ₹1,460.
The company’s stock closed comfortably above the ₹1,600 mark on Monday, June 19. InCred Equities, which recently initiated coverage with an add rating, sees a huge upside from the current stock price and has set a target price of ₹2,462.
“The industry is cyclical in nature, and it’s important to start at the beginning of an upcycle. We expect the graphite electrode cycle to play out in the next 12-18 months. However, in the medium term, muted Chinese demand will lead to some headwinds,” it adds.
HEG, unlike its peer Graphite India, has one more growth lever ahead – as it’s venturing into making graphite anode for Lithium-ion cells. Its graphite anode plant for these batteries is expected to be commercialised by FY25.
While it can act as a growth trigger, there is a downside risk as well. “It could be ultimately replaced by silicon anode, which doesn’t use graphite at all and hence, could prove to be a significant business risk,” says InCred Equities.