SKP Securities - HEG

SKP Securities report on HEG:

Company Profile:

HEG, a premier company of the LNJ Bhilwara Group, is India's leading graphite electrodes manufacturer. HEGL has its graphite manufacturing plant located in Mandideep (Madhya Pradesh) with a capacity of around 52,000 MT per annum. The Company also operates a sponge iron plant, a steel billets plant, and captive power genaration units totaling 56.3 MW.

Investment Rationale:

Unalleviated demand from the steel industry:

Steel manufacturing companies with electric arc furnace are the only consumers of graphite electrodes. With the increase in the adoption of electric arc furnace method to produce steel and limited number of graphite manufacturing companies, the demand for graphites is expected to rise in future, thereby ensuring constant growth in revenues and profitability for the company.

Escalating Margins:

HEGL's Operating Profit Margins (OPMs) has improved significantly since FY04 after it spinned-off its textile unit. HEGL has been able to maintain the OPMs over 21% for the last two years due to higher realizations from the graphite electrodes and we expect the company to continue to do so in the future.

Continuous expansion to meet the growing demand:

HEG Ltd. had increased its graphite manufacturing capacity from 33,600 mtpa in FY05 to 52,000 mtpa in FY06. This will be further increased to 57,000 mtpa in the current financial year by de-bottlenecking the production process.

Captive power plant to lower the overall production cost:

HEGL has its captive power generation facilities with a total capacity of 51.3 MW and it plans to set up another power plant with a capacity of 30MW. This will save a considerable amount of power cost thereby improving the overall margins.

Management's stewardship to drive the company to growth path:

HEGL is a part of LNJ Bhilwara group of companies, which has its interest in diverse fields i.e, Textiles, Graphite & Steel and Power Generation & Consultancy. Being a part of such a management, which has an experience in managing the businesses over several decades, assures the best of operations for HEGL.

Outlook & Recommendation:

Visualizing the demand for graphite in the steel industry, HEGL had increased its manufacturing capacity over the period. HEGL being the leading graphite manufacturer in India will be able to realize the benefits of the rising demand and increasing prices. At the current level of Rs 164.40 HEGL is trading at 6.90 x FY08E earnings and 5.77 x FY09E earnings of Rs 23.83 and Rs 28.48 respectively. We rate the stock a BUY with a 1-year target price of Rs 225 at 8x FY09E earnings, giving it an upside potential of 35.14%.