Graphite India Limited, India’s largest graphite producer stands to benefit from its capacity expansion plans along with steady increase in demand for its products in steel industry.

Business

Graphite India Limited engages in manufacturing and marketing of graphite electrodes, coke, impervious graphite equipment, glass reinforced plastic (GRP) pipes and tanks, high speed steel apart from having a small presence in power generation business.

The company with a current installed capacity of 78000 metric tonne per annum (mtpa) accounts for nearly 6.5% of global electrode capacity and is one of the largest graphite producers in the world. It has four graphite electrode manufacturing units at Durgapur, Bangalore, Nashik in India and Nurnberg in Germany.

The company’s business can be classified into four segments.

Graphite and carbon segment: This segment contributes nearly 84% to company’s consolidated revenues where it produces electrodes, anodes and other miscellaneous carbon and graphite products apart from calcined petroleum coke (CPC), electrode paste and tamping paste. The company specialises in manufacture of high margin value added large diameter, ultra-high power (UHP) electrodes.

Steel segment: The company derives close to 6% revenues from this division where it manufactures high speed steel and alloy steel. It is the largest producer of high speed steel in India with a market share of 60%.

Power segment: The company has an installed power generation capacity of 33 mw, which is mainly used for captive purposes and a small portion of hydel power is sold.

Others: The company manufactures graphite equipment like heat exchangers, pumps, columns, etc used in corrosive chemical industries. The company also manufactures GRP pipes and tanks used for water supply, effluent collection and disposal, and storage purposes.

Investment rationale

The company’s main product — graphite electrode — is used as a consumable item in steel production through electric arc furnace (EAF) route. EAF is expected to contribute 50% of global steel production by 2020 from current 30% levels with most of these steel mills requiring UHP electrode. This would benefit Graphite India as it holds dominant share in highly concentrated industry with high entry barriers.

Led by strong demand from automotive, consumer durables and infrastructure segments, there has been huge investments lined up to increase steel production in the country. India, currently fourth largest producer of crude steel is likely to take the second spot over next 5 years. Also as almost half of these investments are adopting EAF route, the firm would benefit from rising demand.

The company has undertaken a brownfield expansion of 20,000 mt at its Durgapur plant which is likely to be completed by end of fiscal 2012. This would help to increase its total installed capacity to 100000 mtpa thereby adding to revenues. Also, the firm would benefit from higher targeted capacity utilisation of 85-90% in the current fiscal.

The graphite electrode industry during last fiscal saw fall in prices due to aggressive pricing by some players. With some big global players recently announcing price hikes, the firm may be in a position to raise prices, thereby improving realisations.

The company would benefit from its contract to get needle coke supplies and power for its Nasik unit at competitive prices.

The company has a diversified client base in more than 50 countries with each of the client contributing not more than 6% to consolidated revenues. The company derives close to 57% revenues from exports.

Graphite India’s strong balance sheet with low leverage and stable cash flows provide comfort that it would be able to fund its ongoing expansion plans and its future inorganic growth plans. The company has a decent dividend payout history as well.

Concerns

The company faces risks from lower steel demand in case of global economic slowdown thereby affecting its export volumes and revenues. Any adverse increase in crude and coal prices would affect the cost of derivative materials thereby impacting the profit margins. The company also faces threat from cheaper imports.

Valuations

Driven by stable demand for electrodes from steel manufacturers and increase in its capacities, Graphite’s revenues are expected to grow at compound annual growth rate (CAGR) of 15% over FY11-FY13E while net profits are likely to grow at over 18% CAGR during the same period on account of better realisations and higher capacity utilisation. At current market price of Rs84, the stock trades at 7.31 times its expected earnings per share in fiscal 2012 and 6.22 times its expected FY13 earnings. Considering its decent valuations and strong balance sheet, investors can consider the stock at current levels from long term perspective.