'Buy' recommended on Graphite India stocks
Weak demand and heightened inventory led to Graphite India's (GRIL) subdued realisations and lower sales volumes (last six quarters). We expect it to benefit, however, from coming tailwinds as these:
- A pick-up in steel production globally (up 2.3 per cent yoy in Q2 FY21)
- The recent rebound in graphite-electrode (GE) prices in China
- Expectations of complete de-stocking of electrode stocks in the next two quarters
- Benign raw material prices.
Q2 FY21 capacity utilisation improved sequentially from 42 per cent to 72 per cent, which, we believe would continue. Hence, we turn positive on the company, thereby upgrading our rating from a Sell to a Buy, with a revised target price of Rs373 (8x FY22 EV/EBITDA), earlier Rs 212.
GE inventory to be exhausted in two quarters: Weak demand from user industries, China's electrode-dumping and huge stocks in the system led to GE realisations ($4,185/tonne in Q2 FY21) coming under pressure (from $12,940 in FY19). GRIL management spoke of complete de-stocking of system-wide electrode inventory in the next two quarters. We believe this should help improve demand for electrodes and, thereby, realisations.
Pick-up in global steel production: After sliding for four quarters in a row, global steel production rebounded in September '20, growing 2.3 per cent yoy, 10.3 per cent qoq. The World Steel Association forecasts steel demand to contract 2.4 per cent to 1,725m tons due to Covid-19, while increase 4.1 per cent yoy to 1,795m tons in 2021. With ~28 per cent of global steel produced in electric-arc furnaces, we expect the fortunes of GE manufacturers to turn around.
Valuations: We expect the company to benefit from the pick-up in steel production and higher realisations in electrodes. We expect it to report an EBITDA loss in FY21 and a Rs 6.6 bn EBITDA Profit in FY22. GRIL is trading at 4.7x FY22e EV/EBITDA. We recommend a Buy on the stock, with a higher target price of Rs 373 (8x FY22 EV/ EBITDA). Risk: Less-than-expected demand for electrodes would cap prices, leading to lower realisations. (Anand Rathi)