Graphite India enjoyed a dream run. Will it overcome the risks?

Graphite electrode makers struck gold in early 2017 after China’s crackdown on pollution resulted in the shutdown of almost a third of its own graphite electrode making capacity.

The result was a huge bonanza for Indian companies like Graphite India that witnessed their product prices go through the roof.

In order to curb extreme volatility in the markets and curtail market risk for gullible investors, Securities & Exchange Board of India along with the stock exchanges decided to implement Additional Surveillance Measures in early June. The measures involve putting stocks that display big high-low variation in trading, high client concentration, multiple price-band hits, high closing price to closing price variation and extraordinarily high PE ratios in a curtailed trading mechanism that will allow trades only with 100% margin and with a 5% price-band.

Some misinformation about the mechanism has caused unwarranted concern and consternation among prospective investors and existing shareholders of companies that find themselves on the list. While the regulators have clearly indicated that being on the ASM list “does not indicate an adverse action against company”, fears abound.

To better inform investors about the fundamentals of several companies on the list, CNBC-TV18 has launched the SEBI WATCHLIST, which will seek to better inform investors about the strengths and weaknesses of the businesses in order to enable them to take more informed decisions, and segregate the bad apples from the good.

What can happen when a business cycle turns extremely favourable? Well, for Graphite India, it means returns as high as 427 percent in one year and 950 percent in two years!

Graphite electrode makers struck gold in early 2017. Demand for these electrodes shot up as Chinese steel exports declined and graphite electrodes were required to fire up electric arc furnaces operated by non-Chinese steel makers around the world. China’s crackdown on pollution resulted in the shutdown of almost a third of its own graphite electrode making capacity. The result was a huge bonanza for Indian companies like Graphite India that witnessed their product prices go through the roof.

 Under the lens

It’s perhaps the huge price surge that landed the Graphite India stock in SEBI’s Additional Surveillance Measures(ASM) list. Having risen from Rs 127 per share to a peak of Rs 907 per share, the last 12 months have been dramatic for this stock. The stock has seen a 13% drop from all-time highs and is currently trading at Rs 786 per share, leaving many wondering if this is a good buying opportunity or whether the best of the run is behind us.

 The Play

Graphite India is one of India’s largest graphite electrode producers. It commands 50 percent market share and has seen a sharp improvement in financials, thanks to the skyrocketing prices of graphite electrodes.

The price of graphite electrodes almost doubled over the last two financial years from around $3730 per ton to an average of $5325 per ton. The huge surge led to a marked improvement in Graphite India’s financial performance over the last several years. Its revenue doubled and EBITDA grew by more than 9 times between FY16 and FY18. Investors lapped up the story and the stock saw a rise in both trading volumes as well as price. So what next?

 Key triggers

Graphite electrode prices continue to stay at heady levels. In fact, prevailing spot market prices range between $17,000 per ton to a staggering $23000 per ton. Graphite India followed a system of setting yearly contracts with customers. Most of these legacy contracts have now drawn to a close and these companies are moving to shorter term contracts which have been renegotiated at much higher prices in sync with the current market dynamics.

As a result, analysts expect bumper financial numbers to continue flowing through in the first quarter of FY19. Another key trigger for Graphite India is the expectation that it will increase its capacity utilisation from 82-83 percent to almost 90 percent this year.

 The risks

A dream run such as the one Graphite India has enjoyed, will of course also come with risks. The biggest one being the cycle itself turning if Chinese players come back in the game with full strength. Indian graphite electrode companies, however, counter this risk claiming they produce much higher quality electrodes which are used by marquee customers around the world.

Another joker in the pack is needle coke- a key raw material for making graphite electrodes. This commodity has been in limited supply which is why its prices doubled in the second half of FY18 over the same period last year.According to Graphite India’s peer HEG, prices are expected to surge another 100-150% this year. However, global giants are debottlenecking needle coke capacity, so the supply should improve. That however, can be a double edged sword. While a rise in needle coke supply will cushion Graphite India’s margins from a raw material shock, it will also allow other global producers to ramp up electrode production.

Supply and demand are everything in the commodity business and even in the market. For now that equation seems skewed in favour of Graphite India.


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