Buy Graphite India – 3QFY2011 Result; Target Rs.114; Angel Broking

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Graphite India – 3QFY2011 Result Update

Angel Broking maintains a Buy on Graphite India with a Target Price of Rs.114.

For 3QFY2011, Graphite India (GIL) posted top-line growth of 21.0% yoy to

`337cr (`279cr), which was below our estimates of `354cr. However, PAT

declined by 29.8% to `44cr (`63cr), mainly because of margin contraction. OPM

came in at 21.7% (36.8%), much below our expectations of 24.8%. The main

reasons for lower-than-expected OPM were a one-time dearness bonus, high

input costs and higher electricity consumption. Going ahead, we expect OPM to

improve from the current levels and the top line to post strong growth.

We maintain our Buy recommendation on the stock.

Disappointment on the top-line and OPM front: For 3QFY2011, GIL reported

below-expectation top-line growth mainly due to price pressures in the domestic

market. OPM also witnessed a decline because of high input costs, dearness

bonus and high electricity consumption due to relatively more graphitisation of

electrodes during the quarter. However, going ahead, OPM is set to improve on

the back of electrode price increases announced by SGL Carbon recently.

Outlook and valuation: Going ahead, we expect volumes to remain robust on

account of high demand for graphite electrodes, with prices also strengthening

from current levels. The company’s expansion plan places it well to capture the

boom in demand. Overall, we expect the company to post a 17.6% CAGR in

sales and a 5.9% CAGR in PAT over FY2010–12E. Owing to lower-than-expected

margins, we have revised our margin estimates for FY2011 and FY2012

downwards to 23.2% and 23.5% from 24.4% and 24.2%. Currently, the stock is

trading at 1.1x and 1.0x its FY2011E and FY2012E BV. We maintain Buy on the

stock with a revised Target Price of `114 (`117).

Segment-wise performance

The graphite and carbon segment posted revenue growth of 21.2% yoy to `294cr

(`242cr), due to 34.0% growth in electrode sales volumes. However, EBIT margins

for the division fell by 1,589bp yoy and 104bp qoq to 18.6%, mainly on account

of rising input costs and moderating electrode prices. However, going ahead, the

outlook is more optimistic, with SGL Carbon announcing a 9–10% increase in

electrode prices.

The power segment posted a 6.4% yoy decline in sales to `9cr. EBIT for the

segment came in at `7cr, which implied an EBIT margin of 81.0%, up 485bp yoy

from 76.2% in 3QFY2010.

The steel segment maintained its strong growth momentum in this quarter as well,

growing by 49.9% to `26cr (`17cr). EBIT margins for the segment came in at

3.1%, as against loss of 2.1% in 3QFY2010.

Revenue of the others segment declined by 5.7% yoy to `21cr (`23cr). However,

EBIT margins expanded by 477bp to 29.1% (24.3%).

Sales maintain growth momentum: GIL has maintained a robust sales growth rate

over the past few quarters, after witnessing a slump during the crisis of 2009.

During this quarter also, sales growth came in at healthy 21.0%. Going ahead, we

expect growth to remain at decent levels, backed by an improvement in the

company’s business outlook.

OPM fell to 21.7%: OPM came in at 21.7% during the quarter, falling from the

higher levels in the past few quarters. In FY2010, the company had posted

exceptionally high OPMs, post which they have returned to normal levels.

However, going ahead, we expect OPM to improve from 21.7% currently.

Fall in OPM leads to a decline in PAT: PAT declined to `44cr in 3QFY2011 from

`63cr in 3QFY2010, mainly on account of margin correction. During 3QFY2010,

the company reported extraordinarily high OPM of 36.8%. Overall, going ahead,

we expect PAT to grow at a much lesser pace compared to the top line.

Management Call – Key Takeaways

􀂄 In 3QFY2011, prices corrected in the domestic market because of aggressive

selling by global majors in India. However, exports markets saw stable prices.

Going ahead, prices are expected to strengthen.

􀂄 Capacity utilisation for 3QFY2011 was ~84.0%, owing to high demand from

steel manufacturers. Electrode sales volumes grew by 34.0% yoy, while prices

declined as compared to the last year.

􀂄 OPM was hit due to one-time wage expenses, high electricity consumption in

the graphitisation of electrodes, high input costs and subdued realisations.

However, most of these factors are expected to reverse in the quarters to

come.

􀂄 Expansion at the Durgapur plant to add 20,000MT of capacity is on track and

the plant is expected to be commissioned in 3QFY2012.

Investment arguments

GIL set to ride on the industry's rebound: The graphite electrodes industry is

expected to grow faster, compared to EAF steel production over the next few years,

as the de-stocking of graphite electrodes inventory on steel manufacturers' end is

expected to reverse. Consequently, we expect volumes of graphite electrodes to

grow at a 17.2% CAGR over CY2009–11E. GIL, with its capacity expanding to

98,000mt/year by FY2012E from 78,000mt/year currently, is well poised to reap

the benefits of this growth. We expect GIL’s market share to increase to 9.0% by

FY2012E and the top line to grow at a 17.6% CAGR over FY2010–12E 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, has plants located mainly across Europe and North America.

GrafTech Ltd., the world’s second largest player, has plants located in France,

Spain, South Africa, Brazil and Mexico. In FY2009, GIL's employee cost was 9% of

sales, whereas it was almost 23% (CY2008) for SGL Carbon. Historically, GIL has

passed on a part of this advantage in order to gain market share. However, with

the rate of market share addition expected to slow down, we expect GIL to retain a

larger part of this cost advantage and, thereby, 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 six players accounting for over 70% of the

world’s total installed capacity. The balance capacity is owned by motley of small

players. The highly consolidated nature of the industry is due to the entry barriers

for 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 greenfield 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 reached 1.4bn tonnes in CY2010, an

increase of 15.0% over CY2009. Graphite electrode volumes have also shown

substantial improvement. GIL reported a 34.0% yoy increase in volumes in

3QFY2011. However, the fall in electrode prices has been more than anticipated.

Therefore, we have revised our top-line estimates for FY2011 and FY2012

downwards by 2.4% each to `1,570cr and `1,864cr, respectively, and PAT

estimates by 8.2% and 6.2% to `220cr and `258cr, respectively. At the CMP, the

stock is trading at 1.1x and 1.0x its FY2011E and FY2012E BV. We maintain Buy

on the stock with a revised Target Price of `114 (`117).