Materials (Steel): Cyclical revival for electrode makers

Capacity utilisation at 75-85% over FY22-24. Needle coke at $2.3K/MT over FY22-24.

Graphite electrodes are used to produce steel via EAF – a lower carbon emission route. We foresee higher adoption of EAF (esp in Asia) as a structural tailwind for Electrode demand. Also, uptick in capacity utilisation and lower supply (Showa Denko closed 40K MT) could aid Electrode ASP (+15-20% YTD). Retain Buy on GRIL & HEG; target EV/Ebitda at 7.5x/6.5x (+10% to hist 10-year average).

EAF tailwind; regional trends: We foresee higher EAF production across many regions (mainly Asia) to act as a secular tailwind for electrode volumes and pricing. For GRIL/HEG, exports are ~45% / 70% of FY20 sales.

Cyclical recovery: GRIL & HEG witnessed sharp downcycle over CY19-H1CY20. However, this seems to be reversing now, with margins recovering both y-o-y and q-o-q (receding losses). An uplift in steel demand across many regions has driven a sharp uptick in capacity utilisations of GRIL, HEG (65-70% in Q3FY21 vs. 35-40% in Q1FY21). Recovery in electrode prices (+15-20% YTD) is typically with a lag effect to steel.

Our estimates: We retain our electrode ASP estimates at $6.5k/MT in FY22e and $7.0-7.5k/MT in FY23-24e. Note that our ASPs are still 40-50% lower than FY19 upcycle peak. Capacity utilisation at 75-85% over FY22-24. Needle coke at $2.3K/MT over FY22-24.

Balance sheet: GRIL and HEG have robust B/S, which act as a strong moat for navigating tough times. As of Dec’20, GRIL’s net cash+investments stand at Rs 25.2 bn, whereas HEG’s gross treasury size was at Rs 14.5 bn.

Reiterate Buy: Post ~2 years of downgrades, now higher visibility of an uptick in ASPs & utilisations could support Ebitda revival from now on – this is in sharp contrast to Ebitda losses over FY20-21. We adopt EV/Ebitda valuation and assign target multiple of 7.5x / 6.5x to GRIL/HEG, a ~10% premium to historical 10-yr average, across cycles.

Our higher multiple factors in cyclical recovery and improving prospects (eg: Electrode ASPs up +15-20% YTD). Our revised PT for GRIL/HEG stands at Rs 810 /2,855. Key risks: Slowdown in EAF, lower utilisation /ASPs, higher needle coke cost.