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BofA-ML
HEG (Buy)
CMP: ₹3,871.05
Target: ₹6,700
We initiate coverage of HEG with a ‘Buy’ rating and PO (price objective) of ₹6,700 - an upside potential of 110 per cent, plus an 8.5 per cent forecast dividend yield. It has seen a significant rise in profitability over the last 12 months as graphite electrode (GE) prices have risen fivefold. Chinese limits on steel production and efforts to cut pollution are lifting steel output by Electric Arc Furnaces (EAF). High entry barriers and limited needle coke supplies mean we see capacity staying tight and a multi-year period of high prices and profit. With 99 per cent of revenue from electrodes, 2/3 as exports, HEG is the purest play on the global sector.
The stock is trading at values well below peers in Japan and China. We attribute this to the current weakness of Indian equities and investors’ lack of conviction in the extent and longevity of the cycle.
Our PO is set at average prior cycle peak earnings/trough level multiples of 7.5x P/E and 5.2x EV/EBITDA for FY20E.
Risks: An easing of China’s anti-pollution efforts, faster capacity additions, a weaker dollar.
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