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Graphite India (NSE:GRAPHITE) is a leading manufacturer of carbon and graphite products in India. It is the third largest graphite electrode manufacturer in the world and the largest in India (by total capacity). The company has a 98,000 mt production capacity with plants at four locations. Graphite India is the largest producer of HighSpeed Steel in the country which has various applications like the manufacture of cutting tools used in automotive, machine tools, aviation, and DIY markets. Graphite electrodes are primarily used in electric arc furnace steel manufacturing, which is preferred for its various attributes like low cost, lower break-even tonnage, low pollution and flexibility of location. According to the World Steel Association (WSA), global steel demand is slated to increase both domestically and worldwide. Graphite India should benefit from this growth trend, given its leading shares in both the markets.
Graphite India Positives
i) Wide product range for diversified applications - Graphite India offers a wide range of carbon and graphite products to a variety of industries and varied applications. It is the pioneer in India for the manufacture of graphite electrodes. Graphite India has 98K tonnes/year capacity, with the flexibility to produce all grades of electrodes. Its large spectrum of product offerings includes Impervious Graphite Equipment, Graphite Speciality Products, High-Speed Steel, Glass Reinforced Plastic Pipes, Calcined Petroleum Coke, and Hydel Power Generation. By products, Graphite and Carbon account for 95% of the company's sales, followed by GRP pipes (3%), and others (2%). Its impervious graphite equipment finds applications in corrosive chemical industries such as pharma, agro-chemical, chloro-alkali & fertilizer industries.
ii) Diversified Sales - Graphite India is not only a leading manufacturer of graphite and carbon products in India, but it also has a large presence in the international markets with exports accounting for 37% of FY2018 sales. The company accounts for more than 12% of capacity among leading global electrode manufacturers. Graphite’s German plant caters to the European markets, while its Indian plants are geographically well located offering logistical advantages to overseas clients. Overall, India’s share in the global steel production pie has almost doubled from a humble 3.3% in 2001 to 6% in 2017. Graphite electrodes are the major raw materials used for steel manufacture using ARC furnace technology and Graphite India is one of the two largest manufacturers of electrodes in the country.
iii) High quality low-cost producer in India - Graphite India has a strong focus on operational efficiency, productivity, and technological know-how. In the last five decades of its existence, Graphite India has developed core expertise in value-added Ultra-High Power electrodes. Over the years, it has inculcated long-standing relationships with key raw material suppliers and has access to low-cost sources of power. Graphite India typically enters into a five-year fixed-price contract, which further protects it from any fluctuation in the future prices. The company continually invests in R&D activities for the development of import substitute materials for Aeronautical, Aerospace, Railway, and other industrial applications.
iv) Attractive industry dynamics - The company’s product quality, the scale of operations and manufacturing platform base are its huge competitive advantages. Due to the high capital-intensive nature of operations, Graphite India’s business requires large amounts of investment. This acts as a strong entry barrier for newcomers. As one of the leading players in a highly consolidated industry, Graphite India is well-positioned to benefit from the demand growth prospects in India. The domestic demand for steel is supported by strong momentum in infrastructure and manufacturing sector. The company should also gain from China reducing its steel and electrode capacities which have led to an increase in production in EAF producing countries. Ultra-high power graphite electrode is being produced only by India, Japan, etc. but the production is limited in China. As China plans to increase its ARC steel manufacturing, the demand for graphite electrode industries is going to increase.
Valuation
Graphite India has a strong financial position supported by a sound balance sheet and consistent cash flows. The company has been compounding both its sales and profit growth in the higher double-digit range since the last decade. It also has a sound track record of paying dividends regularly and sports an impressive dividend yield of more than 17%. Its operating margin is one of the highest amongst peers. The shares are currently trading near the Rs 300 mark, very cheap at 1.75x its earnings. The stock has tripled in value in the last five years. Though stock return has slowed down recently as a result of pricing pressure and global industry dynamics. However, Graphite India stands solid ground as it is an important player in a niche segment in India. Graphite electrodes are experiencing high global demand due to their increased usage in ARC furnace method of steel manufacturing as it is less polluting. Graphite India has a market capitalization value of Rs. 5,900 crores. Its ROCE and ROE multiples are also very high.
Graphite India Stock Performance
Source: Money Control
Challenges
Graphite electrode is currently facing intense pricing pressure which has crept in due to a number of reasons like increase in prices of primary raw material and global industry dynamics. Shortage of petroleum needle coke, the raw material used in the manufacture of graphite electrodes has led to an increase in raw material cost (accounts for 40%-45% of total cost). There is an increase in demand for needle coke as it is also used in the manufacture of lithium ion batteries, whose demand is expected to rise on account of electric vehicles. However, needle coke shortage will restrict the addition of new capacities.
Growing imports and the withdrawal of anti-dumping duty on electrodes (non-UHP grade) made in China (in September) will also have a negative impact on overall prices and volumes in India. UHP prices have been impacted by weakness in steel prices. HEG Ltd. is Graphite India's biggest rival. The two companies account for close to 25% of world production. As a result of the threat of US sanctions, India has stopped exporting graphite electrodes to Iran, which accounted for 8%-10% of total exports (from Graphite India and HEG Ltd.). However, Indian graphite exports stand a good chance to benefit from the ongoing trade war between the US and China and increase exports to the US.
Conclusion
Steel production over EAF (electric arc furnace) route is expected to increase worldwide, driving GE consumption. Recent capacity shutdown in China and decreased exports to other EAF producing countries should act as strong tailwinds for electrode demand and price. Moreover, China will have to depend upon imports in order to meet its needle coke requirement for UHP grade electrodes. A lot of the speculation around prices of graphite electrodes depends upon if China could successfully install capacities for manufacturing UHP grade electrodes, which it currently lacks facilities and specific raw materials. Only time would tell if they succeed.
The shares of Graphite India are trading at very low levels and investors could look at building a small position in the stock with a two-year investment horizon, given the high demand for steel in the country and the company's unique position in the electrode manufacturing in the world. Graphite electrodes are a very necessary element for steel manufacturing and its demand growth is supported by increasing steel requirements worldwide. Graphite electrode is a commodity and the time to enter a commodity cycle is when it hits the lows. Positive industry trends such as strong global steel demand, a rise in electric arc furnaces, and a growing manufacturing and infrastructure industry in India provide strong growth impetus for Graphite India. The company should benefit from growing Indian steel demand in the long run.
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