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For 2QFY2011, Graphite India (GIL) posted in-line top-line, which increased
16.0% yoy to `324cr (`279cr) on the back of the 48% yoy increase in sales
volumes. OPM for the quarter came in strong at 26.1% as graphite electrode
prices stabilised during the quarter. With the global steel industry showing signs of
revival, the company is well poised to benefit from the capacity expansion that it is
currently undertaking. At current levels, the stock is trading at 1.2x and 1.0x
FY2011E and FY2012E book value, respectively. We maintain a Buy on the stock.
Strong volumes drive top-line and margin expansion: The robust volumes growth
of 48% yoy and 34% sequentially drove top-line up to `324cr. Even though
realisations fell, graphite electrode prices were more stable during the quarter
compared to the previous few quarters. As a result of high volumes, OPM was
strong at 26.1% qoq. However, yoy OPM fell by 1,322bp owing to low-cost
inventory in 2QFY2010. The company reported high other income, which was
off-set by the one-time voluntary retirement scheme (VRS) charge of `12.7cr at the
Bangalore plant. Consequently, PAT came in at `49.2cr. Adjusting for the onetime
expense, PAT was `62cr.
Outlook and Valuation: Demand for graphite electrodes is expected to remain
strong on the back of higher steel production across the globe. The company’s
capacity expansion is expected to lend a boost to its future growth prospects.
Overall, we expect GIL to register a CAGR of 19.1% in top-line and 8.2% in profit
over FY2010-12. At current levels, the stock is trading at 1.2x and 1.0x FY2011E
and FY2012E P/BV, respectively. We maintain a Buy on the stock, with a Target
Price of `117.
Segment-wise performance
The graphite and carbon segment reported a 19.2% increase in top-line to `275cr,
mainly on higher graphite electrode volumes. EBIT margins came in at 19.6% for
the quarter, compared to 38.3% in 2QFY2010. Notably, the company had the
benefit of low inventory costs during 2QFY2010.
The power segment revenues jumped 64.1% yoy to `8.4cr, while EBIT came in at
`7.6cr, implying EBIT margins of 91.0%. The steel segment showed strong increase
in sales, registering a yoy growth of 54.2% to `23.0cr (`14.9cr). The division
posted EBIT of `0.2cr v/s a loss of `2.7cr in 2QFY2010.
Sales of Others division declined 21.8% yoy to `28.1cr (`36.0cr). The division
recorded EBIT of `8.0cr, implying EBIT margin of 28.6%.
Management call – Key takeaways
Capacity expansion by 20,000MT at the Durgapur plant is on schedule and is
expected to get completed by 3QFY2012, while the 50MW power plant is
expected to be completed by 4QFY2012.
To optimise costs at the Bangalore plant the company is implementing the
voluntary retirement scheme. The scheme cost the company `12.7cr during
2QFY2011, but is expected to save approximately `6.0cr annually.
Average capacity utilisation at the company’s plants was 78.0% in 2QFY2011,
compared to 40.0% in 2QFY2010 and 60.0% in 1QFY2011.
The steel segment witnessed strong demand on both the domestic and export
front.
The company is fully covered for the needle coke requirements for FY2011.
Investment Arguments
GIL set to ride industry rebound: The graphite electrodes industry is expected to
grow faster, compared to EAF steel production over the next few years, as the destocking
of graphite electrodes inventory on steel manufacturers' end, is expected
to reverse. Consequently, we expect graphite electrodes volumes to register 17.2%
CAGR over CY2009-11. GIL, with capacity expansion from 78,000mt/year to
98,000mt/year, to be completed by FY2012E, is well poised to reap the benefits of
this growth. We expect GIL’s market share to increase to 9.0% by FY2012 and topline
to post 19.1% CAGR over FY2010-12 on the back of this expansion.
Strong labour cost advantage: GIL has strong labour cost advantages compared to
its global peers, as the other companies have their plants in locations where
labour costs are significantly higher compared to India. The largest global player,
SGL Carbon SE, has plants located mainly across Europe and North America.
GrafTech Ltd, world’s second largest player, has plants located in France, Spain,
South Africa, Brazil and Mexico. In FY2009, GIL's dmployee cost was 9% of sales,
whereas it was almost 23% (CY2008) for SGL. Historically, GIL has passed on a
part of this advantage to gain market share. But, with market share addition
expected to slow down, we expect GIL to retain a large part of this cost advantage
and in turn improve its margins over historical average levels.
Strong entry barriers: The global graphite electrodes industry is characterised by
high level of consolidation, with the top-6 players accounting for over 70% of the
total installed capacity in the world. The balance capacity is owned by motley of
small players. The highly consolidated nature of the industry is owing to the
barriers for the new entrants. For instance, only the top global players have the
technology to manufacture high-quality ultra high power (UHP) graphite
electrodes. The industry is marked by a relationship and referral based model. A
new entrant has to prove the quality of its products by supplying to a steel
manufacturer and then get referral and word-of-mouth publicity for the products
from the manufacturer. Another barrier for the new as well as some of the existing
players is the high cost of setting up a green-field graphite electrodes
manufacturing facility.
Outlook and Valuation
We maintain our positive stance on GIL on account of revival in the global steel
production industry. Global steel production for 9MCY2010 increased 20.3% to
1,046 million MT from 869 million MT in CY2009. Accordingly, graphite
electrode volumes have also shown substantial improvement. GIL reported a
48.0% increase in volumes yoy in 2QFY2011. We expect sales to increase at a
CAGR of 19.1% yoy over FY2010-12. OPMs are expected to remain high at 24.4%
in FY2011 and 24.2% in FY2012. PAT is expected to register a CAGR of 8.1% over
FY2010-12. We expect the company to post an EPS of `12.3 in FY2011 and `14.0
in FY2012.
At current levels, the stock is trading at 1.2x and 1.0x FY2011E and FY2012E book
value, respectively. We maintain a Buy on the stock, with a Target Price of `117.
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