HEG Limited (HEG) Earnings Call Transcript & Summary

Ladies and gentlemen, good afternoon, and welcome to the HEG Limited conference call to discuss the company's Q3 FY '20 results. Joining on the call today is Mr. Manish Gulati, COO and CMO, HEG Limited; Mr. Gulshan Sakhuja, CFO, HEG Limited; and Mr. Om Prakash Ajmera, Group CFO, HEG Limited. [Operator Instructions] Please note that this conference is being recorded. At this time, I would like to hand over the floor to Mr. Manish Gulati. Thank you, and over to you.

Good afternoon, friends, and welcome to our Q3 FY '19, '20 con call. This is Manish Gulati, and I just wanted to share with you that I've been appointed as Executive Director of the company with effect from 1st of March 2020. So in the year 2019, total world crude steel production registered a growth of 3.4%, which came mainly on the back of a high 8.3% growth coming from China. But if you look at the steel production in the rest of the world, without China, after 2 years of positive growth, it was minus 1.7% last year. Now China, which produced 50% of the total world's steel in 2016, has been continuously growing in production and today, they now produce 53% of all steel made in the world. The Electric Arc Furnace steel production was down in some of the large steel producing regions, like Europe, Japan, U.S., Turkey, mainly resulting from a slowdown in demand, the trade tensions between U.S. and China and other geopolitical tensions in some parts of the world. Iran steel production, which is mainly EAF-based grew in 2019 by 30%, but due to sanctions, we could not participate in this growth. Due to reduced demand of electrodes and large inventory overhang, which was caused due to customers buying much higher volumes of electrodes in 2018 and in the first few months of 2019, on account of the unprecedented increase in electrode prices month after month, we have seen much less buying in the last couple of quarters. As you're all aware, graphite electrodes has a long production cycle, anywhere between 6 to 8 weeks, to 20 to 24 weeks for different category of electrodes and nipples that we produce. Moreover, as our primary raw material Needle coke is totally imported by us from Europe, U.S. and Japan, at any particular time, we have a large inventory of Needle coke in stock on seaborne transit and work in process, given the above stated production cycle. And finally, in the form of finished electrodes. While the electrode prices have corrected in the past few quarters, we are -- we still keep consuming high-priced coke. Since the past year, the electrode prices have been sequentially dropping quarter after quarter to reflect the market conditions. As the customer has overbought in 2018 and first half of 2019, the new purchases have come down to more normal operating levels. This has led to a drop in our revenue and EBITDA margins, et cetera. However, one of the largest industries there, from Japan, has recently announced a shutdown of one of its plant impacting a reduction of 40,000 tons of electrode capacity and is further considering temporary idling of another 25,000 to 27,000 ton capacity in Europe. This should help in stabilizing the market. On our side, we are vigorously pursuing our expansion, which is going as per original schedule, and as planned, it should be operational in quarter of 2022. Our plant with an installed capacity of 80,000 tons is currently the single largest plant in the world. And by addition of another 20,000 tons, it would become even larger, giving us significant advantage in cost. We are happy with the timing of our expansion. And we believe, by then, the world market for electrodes would have grown larger to absorb this 20,000 ton additional electrodes easily adding to our international market shares. The Needle coke availability has substantially eased compared to the recent past due to reduced demand from GE producers and more importantly, an overhang of inventory both with all the electrode producers as well as Needle coke producers as explained above. And accordingly, the pricing of Needle coke are significantly coming down. Our sales in Q3 were at low-50 utilization level, and we expect it to become better from this quarter onwards, as the demand picks up gradually. We do believe that with this new capacity coming on stream, quality of our products will see a marked improvement due to state-of-art equipments and the latest available technology that we are currently in process of installing. This would have a positive impact on the quality of our products. In addition, this will also enable us to do cost savings due to economies of scale and also achieve better efficiencies. With our 4 decades of experience in business, we expect to be a supplier of choice to all our global and Indian customers. With this, I would now hand over the floor to our CFO, Gulshan, to take you through the financial numbers. And then along with our group CFO, Mr. Ajmera, we will be very happy to answer any queries that you may have. Over to you, Mr. Gulshan.

Yes, thank you. For the quarter ended December 2019, HEG recorded revenue from operations of INR 394 crore as against INR 564 crore in the previous quarter and INR 1,865 crores in the corresponding quarter of the last financial year. EBITDA including other income stood at INR 32 cr in quarter 3 versus INR 174 crores of previous year quarter, and INR 1,351 crores in the corresponding quarter of the last financial year. The company reported a net profit of INR 6 crores in quarter 3 as against profit of INR 179 crore in the previous quarter and INR 867 crore in the corresponding quarter of last financial year. The company is debt-free and have been handling our treasury operations to the tune of nearly INR 1,200 crores as on December 31, 2019, and the average return has been around 8% per annum on the same. The company is having a history of maintaining a payout ratio of around 30% to 35%, and we do expect to maintain the same in the current financial year. In line with that, our Board has already approved a payment of interim dividend of 250%, that is 25 per equity share. For the quarter ended December 2013, the company has presented consolidated financial results along with our stand-alone results as a part of the compliance with SEBI circular. The company aims to further strengthen its balance sheet through effective working capital management, thereby creating value for its stakeholders. And now we would now like to address any questions or queries you may have in your mind. Thank you.

[Operator Instructions] The first question is from the line of Sonali Salgaonkar from Jefferies.

So my first question is I just wanted to understand what has changed substantially in Q3 versus Q2, which is why we are seeing the results sharply down sequentially as well. And where do you really see the realizations bottoming out?

Right. Okay. So if you are asking what has happened between the 2 quarters? There has been less sales. As we said, the Q3 was in the low 50s, and Q2 was in 60s. So that is one reason. And the next reason is a drop in prices or rather adjustment of prices. Coupled with that, we have the Needle coke and our WIPs and finished goods, which were made from the highest price of coke it could get. So -- then the electrodes prices are falling, and we are holding inventory, which is at the earlier raw material prices. So that is what has hit us for Q3.

Got it. And where -- do you see this as probably the bottom of realizations? Or do you still think that there's still some more pain left?

No, I think this should be the bottom. I think so. I hope so, because there is not much room left to go below this -- these levels which you are having. And once we have this high-cost inventory out of our system, the margins should return.

So by when do you foresee the high cost Needle coke inventory to be out of your system?

So let's say, safely take 6 months.

That's 2 quarters from now?

Yes.

Sir, my second question is, probably you could choose to answer this from an industry level. What is the current level of inventory of graphite electrodes that you see the industry is sitting on? And probably, what time line do you expect to liquidate this?

Again, see, people globally, including us, we have adjusted our production levels to reflect the market demand and give time to customers to adjust their energies, which they have. I believe that once people are working on lesser capacity utilizations, not only us, but everybody else, this should now again take 6 months to either liquidate excess inventory that overhang or excess inventory these customers are holding. So we -- probably we have to give everybody a 6-month time frame because, of course, and people have realized that, yes, there's not enough demand in the market. So all the companies have adjusted their capacities to whatever level they could. And again, for the same reason that we have to adjust to the new level and exhaust excess inventories.

Sure. So my next question is from the perspective of Needle coke. So just wanted to understand probably, what is the current cost of Needle coke? And typically, what is the duration of the contracts? And when is the next renewal up?

See, right now, we have excess inventory, then we'll probably know about the Needle levels sometime in March, what kind of -- right now, we are not buying any Needle coke, but we of course have a sense that prices are coming down, probably in the month of March, then we will talk about if -- beyond, we'll have a sense of where the pricing is. So far, the pricing has been 6-monthly at the time. But in the steel conditions, we will see, it all depends on the market. And in good old days, there were -- we used to get into a year-long contract with customers because we used to have year-long back to back contracts for Needle coke. And then the market went hard, it became 6-monthly, then it became 3-monthly. Now we will see in March. I mean, we will see both ways, whether we are willing to get into a 6-month contract, if we don't have enough visibility. Likewise, they can also take a call.

Sure. And would it be able for you to share what is the current cost of Needle coke?

I wouldn't like to say, ma'am, for competitive reasons. But yes, you can. I mean, we have enough data in the market, you can figure out, but I would not like to mention a -- put a figure to that, ma'am.

I understand, sir. Sir, my next question is related to coronavirus and the probable supply chain disruption in China. Do you see the imports of Chinese graphite electrodes getting affected because of this? Or have you seen or come across any data that they have come down from the start of January to the mid of Feb?

See -- I think to be able to properly answer this question, another few days may be required. Because you see before the Chinese went for the holiday, everything was planned and everything was done, organized accordingly. Now it's about a week or 10 days that they are back, and I don't know whether they are back, but maybe another few days, like you and everybody is watching the situation very closely, but I can only share, which is common sense, that if it lasts for a little longer, not only electrodes, several other industries would be impacted. So we should -- I mean we should see some decline in exports, not only in India, because China was exporting a lot of the lower grade, high-power electrodes to several countries in the world. So another few days and it will become clearer actually. Today, I cannot hazard a guess.

Got it, sir. Sir, could you provide us your current breakup of UHP versus non-UHP and export, export versus domestic?

Export versus domestic is about 70%-30%, and UHP versus non-UHP keeps varying a little bit, but if you take an average, it is about 20% to 25%.

Sorry, what is 22%?

20% to 25% is on the portion of our non-UHP platform.

Non-UHP, I understand, sir. Sir, how are the exports doing in any particular geographies where you are finding constraints or probably a lot of competition because China is exporting in them?

No, but China -- the competition, which we have with the China is only for that 20%, 25% of our non-UHP grade, which we make. We do not have straight competition with the Ultra High Power grid, which is our main stake. So I mean this has always been, not only now, they've been -- for the last so many years, we have been competing with this 20%, 25% of our business segment. So it's not restricted to any geography, and that they were exporting this lower grade to so many countries. So we compete with them everywhere.

Sure. Sir, any particular geographies, which are doing well or not so well export-wise?

If you see, I mean, Europe has a lot of slowdown in steel. If you look at the world steel production figure, I can share with you -- it's, let's say, the steel in the Electric Arc Furnace down in Japan, Turkey, South Korea, Russia, Italy, Mexico, Germany. Most of these major steel making countries are down in production. The only place where they seem to be growing is Iran, which is out of our purview. And United States is growing in steel and India is growing in steel. So other than that, the European part is significantly down in production.

Got it, sir. Sir, are the realizations of export and domestic comparable?

Domestic realizations have become much less. The pricing in India has become much too aggressive because it's a home market, and there will be price declines. So -- but in export, it's better, I would say, better than in domestic.

Would it be able for you to quantify the differential?

No, not exactly. But please don't ask for that. Certainly possible -- it's certainly better, I would say.

Sure. Sir, and my last question, in the opening remarks, you mentioned that there's a 40,000 metric ton shutdown of graphite electrode capacity in Japan. Which player are you referring to?

Which -- sorry, which?

Player? Which company are you referring to?

I said in my speech, that this is the largest. But it would not be nice on my part to name all these competitors, but it is very easy for you to find out the largest player. I clearly said in my speech, the largest industry player is from Japan.

Sure. And when have they shutdown?

This news, which we have is about a week old -- a week or 10-day old. Yes. So I think we announced it on 6th of Feb.

[Operator Instructions] The next question is from the line of Bhavesh Chauhan from IDBI Capital.

Sir, I just want to know, can you quantify the volume decline that has happened year-over-year or in this quarter?