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The demand for graphite electrodes is driven by the production of steel through the electric arc furnace route.

Srividhya Sivakumar

Exposure can be considered in the stock of Graphite India. A well-timed capacity expansion may help the company capitalise on the increasing demand for graphite electrodes and hardening electrode prices.

This offers Graphite India a significant potential for upside in earnings. At the current market price of Rs 50, the stock trades at a modest 6 times its likely FY-09 per share earnings. This appears attractive and does not capture the growth potential for the company. Long-term investors can consider accumulating the stock in lots, given the volatility in the broader markets.

Graphite India is primarily involved in the manufacture of graphite electrodes, which is a consumable item for the steel industry. The company also makes and sells heat exchangers, ejectors and pumps, It also manufactures glass-reinforced plastic pipes and tanks.

Graphite India has a capacity to manufacture 78,000 tonnes of electrodes per annum. Further, it has a 33 MW captive power plant and a 30,000 tonne calcined petroleum coke facility, which provides it greater flexibility to manage costs.

The demand for graphite electrodes is driven by the production of steel through the electric arc furnace (EAF) route. The EAF uses graphite electrodes to conduct electricity, which, in turn, generates sufficient heat to melt the scraps of steel.

This process of steel production is slowly gaining ground and is expected to grow further. Rough industry estimates of graphite electrode demand also suggest a positive scenario.

From about 1.02 million tonnes in 2001, the global demand for graphite electrodes is estimated to increase to 1.34 million tonnes in 2010. With no significant capacities being added globally to the current capacity of about one million tonnes, established players should stand to benefit.

The demand for graphite electrodes is spread across the US, South America, Europe, Japan and China, which are the principal manufacturers of steel through the EAF route.

The domestic market, on the contrary, is yet to switch completely to the EAF route. Historically, the lower preference for steel production through EAF in India can be traced to the rich iron ore reserves in the country, but this may change with increasingly tight iron ore supplies and escalating prices. Besides, steel scrap, which is a major requirement of steel production through the EAF route, is still not generated on that massive a scale in our country compared to the developed countries. Nonetheless, given the lower cost of production and the likely improvement in power availability, it may only be a matter of time before Indian manufacturers too take to this route completely.

Strong demand from the steel sector, coupled with the limited electrode capacity additions industry-wide, have helped Graphite India significantly improve its realisations over the years. Realisations have improved despite a rise in needle coke prices — a critical raw material used in the production of graphite electrodes and is supplied by a few players worldwide.

This makes Graphite India’s ability to secure raw materials critical. The company has so far exhibited efficiency in securing needle coke supplies on time. However, any unprecedented hike in needle coke price may put pressure on the company’s profitability. While it may may be able to pass on input increases partly to its clients, significant hikes may not be passable.

Graphite India has reported a compounded earnings growth of over 56 per cent on the back of 18 per cent growth in revenues over the last three years. Improving realisations, higher capacity utilisation and expansion in operating margins have helped this growth. The same period also saw operating margins expand by over three percentage points to reach the current levels of about 19 per cent.

Going forward, we expect margins to remain stable at these levels, given the company’s tight focus on improving cost-efficiencies. It has facilities to generate captive power which is likely to lead to a considerable savings in cost. Savings from reduced freight cost and the zero impact of anti-dumping duty due to Graphite’s presence in Germany may also help on the margin front.

For the quarter ended December 2007, the company reported 28 per cent growth in revenues.

However, lower ‘other income’ component due to forex losses and a higher depreciation muted the earnings growth.

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