Monday, March 29, 2010


In a global outperformance phase…

The Indian graphite sector is currently going through a phase of global outperformance in a technology intensive industry on the back of cost competitiveness and sound operations of domestic graphite producers. Graphite demand has started improving globally. An improvement in steel production and robust product prices have led to a fine performance by Indian graphite players in 9MFY10 leaving global peers far behind. Capacity expansion is underway and low cost operations are ensuring better margins as compared to global peers. Hence, we expect Indian graphite companies to continue their outperformance over international players and increase their share in the global graphite market from ~13% in 2009 to ~18% in 2012E. We are initiating coverage on the graphite sector with a STRONG BUY rating on HEG Ltd and an ADD rating on Graphite India Ltd (GIL).

■ Bounce back in steel production to propel graphite electrode demand
Steel demand suffered a sharp drop from Q4CY08 and through much of 2009. This was on account of the global financial crisis that led to a severe drop in EAF steel production and the resultant graphite electrode demand. With the recovery in steel production growth firmly in place, we expect graphite demand to increase by ~17% YoY in 2010 on the back of steel
production scaling back to pre-crisis levels.

■ Ongoing capacity expansion ensures economies of scale
Indian graphite manufacturers enjoy competitive operating advantages with low manpower costs, captive power feeds and strategic location benefits. Brownfield capacity expansion (ranging from 13% to 21%) at existing locations being carried out by both Indian graphite producers
would lead to further cost savings with economies of scale.

■ Low cost structure ensures highest capacity utilisation, margins globally
Indian graphite producers have operated at higher capacity utilisation rates (45-75%) as compared to global peers (35-55%) even during recessionary periods (CY09) due to their low cost structure. Production cuts in response to a drop in demand have been more pronounced for high cost producers in the developed world. Domestic players have weathered the storm better. With the low cost structure being further improved upon, domestic players are expected to enjoy better margins (higher by 500-1000 bps) as compared to global peers, going forward.

Outlook and recommendation
Indian graphite players have remained at the forefront of the recovery in graphite electrode demand globally. Apart from operating at higher capacity utilisation levels and achieving better profit margins as compared to global peers in the last few quarters, they have also announced capacity expansion plans recently. Despite possessing strong business models, the current valuations of domestic players are at a steep discount to global peers and leave room for upside. We are initiating coverage on the graphite sector with a positive view. HEG Ltd is our top pick in the space on account of its single location advantage, higher margins and value accretive investment in Bhilwara Energy Ltd.

To read the full report: GRAPHITE SECTOR