After 956% surge in a year, analysts now turn cautious on HEG

Given the stellar performance over the past year and what lies ahead, analysts are now turning cautious on the graphite electrode space. They see limited gain for the stock from here on

China’s clamp down on polluting industrial plants that triggered a shut-down of nearly 30 per cent of graphite electrode capacity last year have proved to be a boon for HEG Ltd, which reported a turnaround performance in financial year 2017 – 18 (FY18).

The consolidated net profit for FY17 came in at Rs 10.99 billion, compared to a net loss of Rs 440 million. For the fourth quarter ended March 2018 (Q4FY18), HEG clocked a net profit of Rs 6.34 billion, as compared to a net loss of Rs 34 million in year ago period.

“Prices of the graphite electrodes (finished product for HEG; used to melt steel) had moved up from $3,000 per tonne to Rs 15,000 per tonne over the past 15 months on the back of China clamping down on polluting industries. This benefitted HEG a lot and the stock did well during this period,” explains Bhavesh Chauhan, an analyst tracking the company at IDBI Capital.

Sensing an opportunity, investors had latched on to the stock early. HEG, which owns one of the largest integrated graphite electrode plant in South-East Asia, has surged a massive 956 per cent in a year and was the top performer in the S&P BSE Small-cap index, ACE Equity data shows. By comparison, the S&P BSE Sensex and the S&P BSE Sensex moved up around 18 per cent and 16 per cent, respectively.

Given the stellar performance over the past year and what lies ahead, analysts are now turning cautious on the graphite electrode space. While they do not rule out the possibility of HEG doing well at the bourses going ahead, they believe the gains from here on could be limited. That apart, the government has imposed to impose an export tariff of 20 per cent on electrode markers, which analysts feel, could hurt operational performance in the long run.

“Though HEG is likely to do well over the next two quarters, the risk-reward ratio for investors allocating fresh money in the stock seems unfavourable now. Though the road ahead for the steel sector looks promising as of now, any negative development can indirectly impact the fortunes of HEG as well,” Chauhan of IDBI Capital cautions.

Meanwhile, some graphite electrode manufacturers who shut capacity in China have been able to secure environmental regulatory hurdles and are likely to augment capacity in 2018-2020 that will dent the overall operational performance of global manufacturers, reports suggest.

“Although government-enforced curbs on production at SMEs have forced many of these smaller producers out of the market in China, companies compliant with environmental regulations have been adding production capacity since the latter half of 2017. We lower our 2019 forecast for margins on graphite electrodes from $6,000/tonne to $3,800/tonne and our 2020 forecast from $6,000/tonne to $2,500/tonne,” says a recent report by Nomura.

Decline in electrode prices and China re-starting its induction furnace capacity for steel production are the two key risks for HEG going ahead, writes Rahul Murkya of Jefferies in a recent report. He, however, maintains a buy rating on the stock with a price target of Rs 3,622 levels, which is around 14 per cent higher from the current levels.