HEG is a diversified company with interests in graphite electrodes and power but it is the power business that is fetching it more profits. Graphite electrodes are used mainly in electric arc furnaces (EAF) in steel plants to melt steel scrap. Their demand is, therefore, sensitive not to steel prices but to steel production volumes through the EAF route which is increasing rapidly.
The outlook for graphite electrodes business seems to be improving. In its latest quarter (Q1FY10), HEG has reported marginally lower graphite sales volumes compared with last year. Revenues touched Rs232.2 crore, a 2% decline over the corresponding quarter last year but EPS increased 50% -- from Rs6.6 per share in Q1FY09 to Rs9.9 per share this quarter. Contribution from exports stood at 65.5% of net sales, while domestic sales contributed 34.5%. Any reduction in profits from reduced volumes in FY10 is likely to get offset by higher realisations of graphite electrodes and reduction in raw material costs.
HEG, currently, has an order book that is only half its capacity which it was not certain to achieve a few months back. It is operating at 60% of installed capacity; the management expects it to improve to around 70%-75% by the end of this year. HEG has cut production by 35%, enabling it to sell surplus power in the merchant power market. Power sales are expected to generate additional profits in FY10, which will be EPS accretive. The company is gaining from a reduction in raw material costs. Power and fuel costs were down on the back of lower capacity utilisation levels in the graphite electrodes unit. At present, HEG's plant capacity is 60,000tpa. In view of the current slowdown in steel industry, HEG has moderated its expansion plans from the present 60,000MT to 66,000MT (as against 80,000MT planned earlier) at a marginal cost of Rs42.5 crore. This should help HEG maintain its lead in manufacturing graphite electrodes.
In the power division, HEG has commissioned a 33MW thermal power plant in May 2009. The full benefits of this plant will accrue from second half of this year. Post-expansion, total power plant capacity has increased to approximately 77MW. The company has significantly improved its margins. Operating margin stood at a fantastic 36% compared with 26% previously. PAT margin touched 18% from 12.5% earlier. HEG's market-cap is 1.12 times sales and 4.21 times operating profit. Not cheap; but buy this stock on 20%-25% decline.
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