HEG Limited – Business Analysis and Its Future

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This post has been written by Himanshu Shah for FinMedium Research Desk.

Table of Content

  1. Company Overview
  2. Product portfolio
  3. Industry overview
  4. The Covid effect
  5. Recent Business Performance
  6. Emerging Trends
  7. Strengths
  8. Risks
  9. Financial analysis
  10. Road Ahead

Company Overview

HEG Limited is part of LNJ Bhilwara group a diversified, reputed and large Indian business house having more than five decades of industrial experience and presence in Textiles, Graphite electrodes, Power Generation & Power Consultancy, IT Enabled Services.

HEG Limited is a leading graphite electrode manufacturer & exporter Globally. It is among the Top 5 Graphite Electrode manufacturers in the world The company produces two grades of graphite electrodes – Ultra High Power (UHP) & High Power (HP) – used in producing steel through the Electric Arc Furnace (EAF) route.

HEG Limited has Graphite electrodes manufacturing plant having a capacity of 80,000 tons /Year located at Mandideep in Madhya Pradesh which is the largest single-site facility in the world.

HEG Limited exports approximately 70% of its production to about 30 countries around the world and has a diversified customer portfolio –supplying a large proportion of our volumes to the top 20 steel companies of the world.

Product Portfolio

Graphite Electrode is the core business of the company(HEG Limited) which accounts for around 80% of the total revenue. HEG produces two grades of graphite electrodes – Ultra High Power (UHP) and High Power (HP) – at its facility at Mandideep, India.

Graphite electrode is a key component for electric arc furnaces (EAFs) that turn scrap into steel.

These are the only products available that have high levels of electrical conductivity and the capability of sustaining extremely high levels of heat generated in the EAF’s demanding environment.

The Ultra High Power (UHP) grade electrodes are used in large furnaces, which are melting furnaces.

The High Power(HP) electrodes are used in ladle furnaces (which support the electric arc furnaces) which are used for refining and do not require electrodes with stringent quality specifications. So UHP and HP are not switchable.

Graphite Electrode business is based upon the steel sector (Electric arc furnaces) which is largely dependent upon the construction sector, automobiles, and other white goods.

Company total production consists of around 75% of UHP Graphite Electrodes and 25% of HP Graphite Electrodes.

Needle Coke is the main raw material used for producing graphite electrode.

For Producing the graphite electrode from needle coke, it takes around 2 to 6 months of production time depending upon the type.

Needle coke is imported by the company and given this long production cycle, at any particular time,company has to keep a margin of two months in terms of carry stock,

HEG Limited exports approximately 70% of its production to about 30 countries that include the USA, Canada, Germany, France, Italy, Australia, and South Korea.

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The Company has a captive power generation capacity of 76.5 MW, comprising two thermal power plants and a hydroelectric power facility, which help in a sustained supply of reliable energy to its graphite electrode facility.

Excess power generated  is sold in the market through IEX and bipartite power purchase agreement with open access to consumers

Graphite Electrode - HEG Limited
Image : Graphite Electrode

Industry Overview

Steel is manufactured through two methods which are blast furnace and Electric Arc Furnace.

Graphite electrodes are the main heating element used in an electric arc furnace, a steelmaking process where scrap is melted to produce new steel.

As Graphite Electrode business is based upon the steel sector (Electric arc furnaces) let’s look at the outlook for steel sector.

World Crude Steel Production Last six Quarters ( Jan 2019 – Jun 2020)

Electric arc furnace is an environmentally efficient way of manufacturing steel. About 45% of the steel produced globally is through this process, except in China.

For every tonne of steel produced through the blast furnace route, it pollutes the atmosphere about 3x compared to an electric arc furnace.

After holding at approximately 25% of global steelmaking production for about a decade through 2012, the migration to electric arc furnace (EAF) steelmaking accelerated in the past eight years.

The EAF steel production hit a new high in 2017 with a 14% year-on-year increase.

This was followed by an additional 10% increase in 2018, taking the EAF contribution of almost 477 MT to 26% of the 1.8 BT of steel produced.

Electronic Arc Furnace(EAF) Steelmaking & Graphite Electrode (GE) Industry

The past two years of 2017 and 2018 and the first quarter of 2019 saw an unprecedented tightness in the supply of electrodes. This fear created a surge in demand.

Many large steel companies overbought electrodes, leading to excess inventory stockpile.

With the steel market getting tougher from the start of fiscal 2019-20, demand declined and production slowed causing an excess inventory of electrodes with the customer.

This cascaded into a drop in demand for graphite electrodes and stabilisation of prices. In keeping with this global trend, all graphite electrode players reduced production by 15-20%

The current year could see the return of normalcy in the market after the projected completion of inventory correction.

The price of UHP electrodes, which saw extraordinary increase over the past two years, have stabilised and the current levels are expected to sustain in the short term.

EAF Growth rate in longer term is positive (~3%).EAF Route is environmentally advantageous as it emits 75% less carbon.These mills are flexible to operate & low capital intensive in cost structure.

EAF accounts for approx. 45% of total World Steel Production (Without China). EAF’s route in global steel production increased from 25% in 2015 to 28% in 2019

BOF Steel : Blast Furnace

China’s EAF steel Production & Finished steel exports

As per Chinese Blue Sky policy ,Country planned to produce 20 % of the steel production by EAF route by year 2020, Hence target steel production for current year should be 200 MMT ( 20 % of 1 Billion steel production of China)

However as per 2019 production fig. recently released by World Steel Association(WSA), China is majorly running behind on achieving this target, resulting in excess Graphite Electrode capacity within China.

China’s steel exports fell to seven-year low in June & expected to stay low in July and August, on a preference for local demand. This gives rest of the world opportunity to produce more steel.

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EAF – the key to be carbon neutral

Looking forward to the next decade, EAF steelmaking will be a big winner in the race to produce green, carbon-neutral steel. European steel producers have worked diligently over the past two decades to reduce the carbon footprint of the steel produced through traditional integrated steelmaking, having accomplished the lowest levels possible from a scientific perspective.

The only path available to them to further reduce their carbon emissions is to shift to EAF production using alternative metallics, diverting large capital investments that would have been used to sustain their blast furnace/basic oxygen furnace (BF/BOF) production with EAFs.

Covid 19 Effect on HEG Limited

As the past years of 2017 and 2018 and the first quarter of 2019 saw an unprecedented tightness in the supply of electrodes. This fear created a surge in demand.

Many large steel companies overbought electrodes, leading to excess inventory stockpile and the COVID-19 pandemic has slowed down the pace of destocking of electrode inventory and fresh purchases at customer end

Needle coke prices have also fallen down reacting to the drop in Graphite Electrode pricing, but not fully in line with the current electrode prices.

Due to the COVID crisis, World Steel Association(WSA) in its recent short-range outlook forecast for the current year 2020, the world steel demand is likely to contract by 6.4%, and the recovery in 2021 will be to the extent of about 3.8%.

Since the past year, the electrode prices have been sequentially dropping quarter after quarter to reflect the market conditions.

And many of our customers have reduced or suspended operations, both of these has resulted in contracting the electrode demand.

The situation in the international market was not as bad as in India. And to that extent, since the company export about 70% of production, company is not as badly impacted as some of the other international players are.

So, Company expects gradual improvement both in the domestic and export market in the next quarter, but the recovery path will be slow.

Recent Business Performance of HEG Limited

Reason for Such a huge Drop-in EBIDTA Margin of HEG Limited

As per the company past history, EBIDTA margin has remained in the range of 20 to 25%..(Except FY 2017-18 and 2018-19)

As per the company management, FY 2018 and 2019 were very exceptional years and a once in a lifetime event which happens suddenly. and the reason for that was China decided to close down about 150 million tonnes of steel, which was all through the blast furnace.

And this means that China which was exporting about 120 million tonnes of steel all over the world, suddenly their capacity to dump steel all over the world went down substantially. So China has now settled at about 60 million tonnes of steel exports.

This means that other part of the world had to produce about 60 million tonnes of additional steel.

And that changed the picture of the electrode industry because suddenly 30 to 35 million tonnes of additional electric arc furnace steel started getting produced which needed graphite electrodes.

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So there was suddenly a mismatch between demand and supply. Due to this graphite electrode and needle coke prices, both went up substantially.

But the difference between the graphite electrode and needle coke prices increased much higher.

And as demand for graphite electrodes, the company’s volume, and margin both expanded which has led to huge EBIDTA margins in 2017-18 and 2018-19 years.

Emerging Trends

Environment-friendly technologies will gain roots in the real world
(renewable energy is a case-in-point).

In keeping with this, experts believe that the EAF route for steel making, being an environment-friendly route, is expected to gain favour in developed and developing economies across the world. This should drive the demand for graphite electrodes over the medium term.

Scrappage Policy by the government in the automobile sector is expected to come soon.

It will also be beneficial for the graphite electrode sector, as Graphite Electrode is used in an electric arc furnace, a steelmaking process where scrap is melted to produce new steel.

Strengths of HEG Limited

Graphite Electrode is an indispensable material for Electric Arc Furnaces (EAF) for Steel production.

High Entry Barrier – HEG Limited the last new entrant in the world in graphite electrode sector in year 1977.

HEG Limited is capable of producing 100% UHP Electrodes with State of the art
manufacturing facility – due to constant expansions & investments

Risks for HEG Limited

The availability and prices of needle coke – one of the key inputs for
graphite electrodes – could emerge as a daunting challenge when the demand for graphite electrodes increases.

This could exert pressure on business margins of HEG Limited.

As Graphite Electrode business is dependent upon the steel sector(Electric Arc Furnace), any slowdown in Steel Sector would impact an graphite electrode sector.

Financial Analysis of HEG Limited

Profit & Loss Statement of HEG Limited for Last 4 years(Rs in Crores)

NarrationMar-17Mar-18Mar-19Mar-20
Sales               858.84           2,747.83           6,591.17           2,144.76
Expenses               777.63           1,026.51           1,932.92           2,150.59
Operating Profit                 81.21           1,721.32           4,658.25                  -5.83
Other Income                   6.66                 12.37               109.19               143.76
Depreciation                 73.92                 72.56                 72.39                 72.13
Interest                 54.72                 56.42                 17.97                 36.51
Profit before tax               -40.77           1,604.71           4,677.08                 29.29
Tax                   9.27               523.37           1,626.65               -24.09
Net profit               -44.08           1,099.34           3,026.16                 67.63
Source : Screener.in

In last 5 years,there has been huge jump in Companys sales and net profit in 2018 and 2019 years,the reason for which already explained earlier.

Balance Sheet of HEG Limited for last 4 years (Rs in crores)

ParticularsMar-17Mar-18Mar-19Mar-20
Equity Share Capital                     39.96                     39.96                     38.60                     38.60
Reserves                   912.60                1,867.56                3,755.09                3,473.12
Borrowings                   683.79                   297.45                   666.79                   594.26
Other Liabilities                   216.16                   534.14                   683.88                   332.37
Trade Payables86246380134
Advance from Customers51512
Other liability items125273303197
Total                1,852.51                2,739.11                5,144.36                4,438.35
Net Block                   888.90                   833.37                   788.38                   744.65
Capital Work in Progress                        1.20                        1.61                     18.58                   100.61
Investments                   230.58                   248.17                   941.73                1,244.75
Other Assets                   731.83                1,655.96                3,395.67                2,348.34
Inventories2585111,3081,005
Trade receivables3619731,187399
Cash Equivalents88557437
Loans n Advances130126281204
Other asset items-253862303
Total                1,852.51                2,739.11                5,144.36                4,438.35

Source : Screener.in

Borrowings include only short term borrowings for Working Capital purpose.

Cash equilavents has gone up from 8 crore in FY 2017 to 437 crore in FY 2020

The company is having a treasury size of more than Rs. 1250 Crores at the end of June 2020.Further, the company is long term debt free.

Road Ahead for HEG Limited

The company is planning to do a CAPEX of around 1000 crores(Already did CAPEX of 250 crores) to expand production capacity from 80000 tons/year to 1,00,000 tons/year till the year 2022.

The company expect the graphite electrode prices to increase in the coming quarters which will increase its EBITDA Margin.

Also watch : HEG Limited Analysis Video here

Read the analysis of Indian Companies here.

This post has been written by Himanshu Shah for FinMedium Research Desk.

Cover Image: ET

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