HEG Limited (HEG) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the HEG Limited Q2 and FY '21 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Navin Agrawal, Head, Institutional Equities at SKP Securities Limited. Thank you, and over to you, sir.

Good afternoon, ladies and gentlemen. On behalf of all of us at SKP Securities, it is my great pleasure and privilege to welcome you to this financial results conference call with the leadership team at HEG Limited. We have with us Mr. Manish Gulati, Executive Director of HEG Limited; and Mr. Gulshan Kumar Sakhuja, CFO. We will have the opening remarks from Mr. Gulati, followed by a question-and-answer session. Over to you, Mr. Gulati, for your opening remarks. Thank you, sir. [Technical Difficulty]

We seem to have lost the line for the management. Participants, please stay connected while we reconnect the management line. We have the line for the management reconnected. Over to you, sir.

Yes. Good afternoon, friends, and welcome to our Q2 financial results 2021 con call. Mr. Ravi Jhunjhunwala, our Chairman, Managing Director and CEO, could not join unfortunately because something very urgent came up. So he got occupied with that. So me, along with our CFO, Mr. Gulshan Sakhuja, we'll be handling this call. This is Manish Gulati, Executive Director, HEG. So I'll begin. More than 1 million lives have been lost due to COVID since the start of the year, and the toll continues to rise. In HEG, we have given top priority to the safety of our employees and put stringent controls at workplaces, including social distancing, use of mask, sanitizing, extensive use of online interactions and work from home, et cetera. These are difficult times, yet there are some reasons to be hopeful. Testing has been ramped up, as you know. Treatments are improving. Vaccine trials have proceeded at a precedented pace, with some now in the final stage of testing. As per the recent data from IMF, which suggests that many economies have started to recover at a faster pace than anticipated after reopening from the lockdown. Hence, we can expect a less severe, though still deep recession in 2020. The World Steel Association in its recent short-range outlook forecasted that in the current year 2020, the world steel demand will contract by 2.4% due to COVID pandemic, and 2021 steel demand is expected to recover with an increase of 4.1% over 2020. The post lockdown recovery in steel demand in the rest of the world has been stronger than earlier expected, but it still marks a deep contraction in 2020, both from developed and emerging economies. There's only a partial recovery expected in 2021. In the first 9 months of the current year, the group's steel production has dropped by almost 12%, excluding China, which is having an impact on graphite electrode demand. The electric arc furnace steel production was down in some of the large steel producing regions like Europe, U.S., Japan, South Korea, besides India, mainly resulting from slowdown in demand. The graphite electrode inventory adjustment, which was supposed to get over by the end of this year, COVID has de-accelerated the rate of depletion of these accumulated stocks. Our results in this quarter were impacted due to lower sales and lower graphite electrode prices, due to reduced EAF steel production in the rest of the world, except China. Capacity utilization for Q2 was about 74%. Since the past year, as you know, the electrode prices have been sequentially dropping quarter after quarter to reflect the market conditions. We now expect the pricing to remain stable and improve from the current levels in the next 2, 3 quarters. We expect resurgence in demand from 2021 onwards, once the impact of COVID subsides, hopefully, and the remaining electrode inventories get consumed. The needle coke availability has substantially eased. And accordingly, the prices of needle coke have come down substantially. We have always been exporting about 2/3 of our own production to more than 30 countries, which helps us in diversifying the market risks. We have seen some recovery in the domestic electrode demand in Q2, which dropped by about 50% in April to June period, with improved production levels at major steel companies. We see a gradual improvement both in domestic and export markets going forward into the next quarter. Electric arc furnace production has seen an approximately 2% to 3% compounded average growth rate over the long term, and we expect this to continue as EAF becomes the preferred choice of steelmaking due to its inherent advantages over blast furnaces, like environmental considerations, low carbon emissions, low capital costs, ease of operations, et cetera. With our 4 decades of experience in business, we expect to be a supplier of choice to all our global and Indian customers. We have taken significant measures to manage our operations in this COVID crisis and ensure the health and safety of our workforce and team members. With this, I will now hand over the floor to our CFO, Mr. Gulshan Sakhuja, to take you through the financial numbers. And then I, along with our CFO, will be very happy to answer any queries that you may have. Thank you.

Thank you. Yes, good afternoon, everyone. I will now briefly taking you through the company's operating and financial performance for the quarter under review. The second quarter started on a positive note with a relaxation in lockdown and gradual resumption of business activities. The company gradually increased its capacity utilization to 74% in quarter 2 FY '21 as compared to 45% in the previous quarter. For the quarter ended September 2020, HEG registered revenue from operations of INR 323 crore as against INR 233 crore in the previous quarter, an increase of 38% Q-on-Q basis, and INR 564 crore in the corresponding quarter of the last financial year. EBITDA, including other income, stood at negative INR 25 crore in Q2 FY '21 versus positive INR 35 crore in the previous quarter and INR 174 crore in the corresponding quarter of the last financial year. The company reported a net loss of INR 34 crore in quarter 2 FY '21 as against a net profit of INR 11 crore in the previous quarter. The performance was encouraged by improvement in the business activity, which was offset by the lower realizations as pricing continued to remain under pressure. Our balance sheet remains robust with a treasury size of about INR 1,400 crore at the end of September 2020. The company has made a detailed assessment of its liquidity position and the recoverability and carrying value of its assets, comprising property, plant and equipment, intangible assets, right of use of assets, investments, inventory and trade receivables. Based on the current indicators of future economic condition, the company expects to recover the carrying amount of these assets. The company is operating its business by optimal utilization of eligible financial resources and also implemented stringent cost control measures across the organization to conserve cash. The company is long-term debt-free and having a treasury size of nearly INR 1,400 crore, yielding an average return of approximately 6.5% per annum. The company has adequate internal financial reporting and control system. The company is having a mechanism to continuously review and monitor its policies and procedures to adopt with the dynamic environment. 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 [ Ujjwal Agrawal from New Horizons Finserv ].

Hello? Yes, am I audible?

Yes.

Yes. Now my question is that when I look at the consolidated results of the company for this quarter, the cost of materials consumed has actually increased for this quarter. I would like to know the reason for that?

Yes. If you see in this particular quarter, we have taken an NRV hit, and that forms a part of my raw material consumption. Therefore, that -- the percentage -- you are observing the increase of raw material consumption on the higher side.

Okay. So that has not been included in the other expenses, but it has been added to the cost of material consumed?

It is a part of cost of material, yes.

The next question is from the line of Bhavesh Chauhan from IDBI Capital.

Sir, just wanted to know, today, as I see in SteelMint, UHP prices of India are at 35% premium to Chinese prices. So does it indicate that Indian UHP prices should fall hereon?

See, what -- I would like to answer this in this way that they are taking Chinese as a benchmark, which is -- that is where the adoption gets wrong because, of course, Chinese electrodes are definitely available at a price of 35% lower than HEG prices. But first of all, they are not 2 UHP products. They're using all kinds of raw materials, blending this, that. So I don't know when -- since when Chinese became a benchmark for all the electrode industry. But probably, they are the only people and one of the websites and SteelMint, and there's some site called Buy Info. So they all keep publishing data, but they're all just comparing Chinese prices with our prices of Indian electrodes, which is not correct, actually. It's not a apple-to-apple comparison. So the price is still under pressure, but that doesn't really mean that it is going to go down, and we don't have to actually match the Chinese price for our product because it's not the same product actually. And customers do understand this. Of course, these kind of news, this was a dampener and confusion in the minds of customers. But all the customers who have used both the electrodes, our electrodes or Chinese electrodes, they know what is what. So we are not unduly concerned about that. We are very much aware that they're selling at this price gap, which you mentioned.

Okay. Sir, that's helpful. And sir, secondly, what is the trend in needle coke prices in the last 1 quarter? Are they going up, flattish?

See, they have been going down in the last, let's say -- now if we count by almost a year, it started early this year, and the prices have been going down. But that is actually not helping us much at this time because we are still holding sizable inventories of material bought in the past. If we were to get needle coke at today's prices and sell the electrodes at today's prices, there would be decent margins. Our problem is that we have to -- till this inventory gets flushed out of the system, which includes raw material, also work in progress, also finished goods and our processing cycle is so long. I mean it takes 2 months to make electrodes and 5 months to make the connecting pins. So till all this gets flushed out from the system, we'll continue to see this pain, which might last for another quarter or so. I mean, this quarter, October to December, and 1 more. And from April, from next fiscal, it should correct.

[Operator Instructions] The next question is from Anuj Sharma from M3 Investment.

Yes. My first question is, if I just look at the realization of our company versus our competitors, our realization seems to be low. What would be the reason for that?

No, I don't think so. I mean if you're looking at our Indian competition, no, it's not low. It also depends on the prodigies, but it is not low. You have to look at the figures and let -- maybe Gulshan can explain this better.

For making this comparison, you have to make the adjustment in our competitor results that they are into the other segments also. The graphite and carbon segment includes their other specialties and other segments. You have to adjust -- make a adjustment to that figure and then you have to arrive at a GE price electrode, because that GE carbon electrode price comprises of other that product also and which forms a part of the graphite electrode and carbon segment.

Okay. Okay. In terms of pricing, it seems that we are roughly $3,000 per tonne of realization, which we are quoting. You seem that -- you believe that this was the bottom or the spot prices are materially different than the realized prices?

This -- first of all, the average realization which you are taking, the dividing tonnage -- the revenue by tonnage, please remember there's a portion of non-UHP electrodes also in this, but I [indiscernible] or something.

So I'm -- just for the sake of simply...

So that you are dividing. And -- but I do hope sincerely that these prices should not go down any further because the spread between the current prices of needle coke and the current prices of electrodes is now enough for all companies to at least have some decent margins and survive and do good for themselves and survive for servicing the steel industry. So this should not go down, I think, because needle coke pricing has also now reached a level where not -- further major decline is not possible. They already went down to the levels which we had seen before they started to increase. So there should not be further decline in prices of electrodes, which you are seeing.

Okay. And in terms of needle coke, how more can you expect the costing to go down? In other words, you would be operating on an incremental basis, not on the historic basis because I account there will be historical cost. On an incremental basis, you said you make decent margins. What would that number be? Would that be around $500 per tonne or...

No, we'll not -- we'll decline to state the specific number because this is confidential, not only to us, but also to the needle coke suppliers. So I'm very sorry, but we cannot give out that number. All I'm saying is that there has been a decline in needle coke prices, and further major decline doesn't seem possible because they're already reaching quite a low level.

Sorry, this, you're talking about the raw material, the needle coke prices is it or the realization?

I'm talking about needle coke first. And of course, the spread between the current prices of needle coke and current prices of electrodes is also now at a level that it should not go beyond this. So that means I'm expecting that this electrode prices will now start bottoming out.

Sure. Sure. And in terms of our raw material, is our inventory now marked to the current prices? Or there is some more to go? So is our inventory now completely marked down to the current realization level?

If you see, as on September 30 quarter, the inventory has already been marked down to the current selling prices. Now NRV is a factor of future selling prices. [Foreign Language] what would be my selling prices for my fourth quarter or first quarter of next financial year? [Foreign Language] that would determine -- and that would determine the actual impact of NRV in the books of accounts. But if I talk about that second quarter, it has already been marked down to that -- inventory has already been marked down as per that current selling prices. But in case if there is any further deterioration of selling price in the fourth quarter or further, then there might be a possibility [Foreign Language] some impact would come.

As per current prices, there is no marked deterioration now from -- in the inventory. That's all marked up?

For September quarter, we have already taken that hit. If you see the notes to that results, we have already shown the figure that have gone down that we have already taken the hit on account of NRV and markdown of inventory.

[Operator Instructions] The next question is from Kirthi Jain from Sundaram Mutual Fund. The next question is from the line of Rajesh Majumdar from B&K Securities.

I just wanted to know something on the new Chinese policy for steel scrap imports, which is expected by the end of the year. What do you mind is expectation on the new policy? Is it going to go back to the old policy? It's not going to go back to the old policy fully, right? So there will still be restrictions on low-quality scrap imports. How is that expected to affect the industry over the longer run?

No. The India was not a net exporter of scrap anyway. So this is -- this Chinese policy doesn't really impact much. What they're trying to do -- I mean they're trying to use their own scrap and stop low quality scrap from coming in. So that way, I mean, we -- India as a country, we won't be impacted much.

No, I'm not talking about the scrap price. I'm talking about the impact of the graphite electrode exports that China is doing right now. So if they are importing more scrap, naturally their domestic industry would consume more of electrodes. So the export pressure, which is there right now might ease with the scrap imports. That's what I was getting at.

Not exactly. Actually, you see if China has not kept up the promise of taking the EAF share to 20%. You remember, there was -- 3 years back, they were talking that, okay, our EAF steel portion is going to be 20% by year 2020. And we're already done with 2020, and they are still at that 104 million, 105 million level. Actually, they should have been at 200 million this year, which would have really eased a lot of problems, and their own internal electrodes would have got consumed there. But still for them, somehow blast furnace gives them better economies. So they did start with a bang. They did increase from a level of 51 million tonnes production from EAF route in 2016. And in 2 years, they came to 2008 -- sorry, 108 million. Then in 2019, it was 104 million. And the way they are going in this year, the steel production is increasing. But again, there -- I mean their reliance is still on the blast furnace route, which is growth against conventional logic because now when the countries develop, the recycling of steel increases. But they -- even they -- despite having their scrap, their electric arc furnace production is not -- still at 10%, 12%, although it should have been 20%.

Right. Right. So if there is a change in the scrap import policy, you don't expect a significant change in that in terms of the...

No. Actually -- that's what I was trying to say. Actually, this policy has lesser of an impact rather than they -- somehow in China, they still find the blast furnace route to be more economical, even if it is environment unfriendly. But probably around $30, $40 a tonne, that is still per tonne of steel made, we still find it more cost competitive, making it through blast furnace route, defying all their earlier policy, which they had made that they want to take the production to 20%. They have not done so. While the rest of the world is around 50% or rather to give a very specific number, it's 48%. So excluding China, 48% steel made in the world is made through the electric arc furnace route. And that is what was expected out of China, to take it from 10% to if not 40% long way off because that is a country still relying more on blast furnace production. But 20% was not difficult to achieve, and they were putting up a lot of electric arc steel furnaces. So I don't know what -- they are not keeping up with their plan, the Blue Sky policy, which they were talking about.

Right. Could that also be because of the fact that scrap prices are very high, the current spreads are not practically enough for the EAF route because...

Yes, that is what I was saying. If you look at the cost of making steel from the both routes, the current scrap prices are still not economical for them. Although it was expected that as an economy, when they're maturing and there is a life cycle to steel, as steel comes in a market in form of scrap, it should have come. But still the scrap prices are such that they still find blast furnace route more economical.

[Operator Instructions] The next question is from the line of Anuj Sharma from M3 Investment.

Yes. My question is, while the UHP technology was with few players, we have -- we heard that China, some players were trying. Any success in China-based players of successful UHP implementation or capacities coming up?

See first, I'll answer the technical part. Then, yes, of course, everybody knows that there's a big learning curve in this and even the same company -- I mean, I'm just giving you an example, even one of our multinational competitors, the world leaders, they set up a new plant in Malaysia. And that plant still gives them a lot of trouble as far as quality is concerned. So it's about -- this process is such that it takes a while for each company to perfect that with the available raw materials, whatever they have. The needle coke is fine, then the pitches are mostly local, the binder pitches, et cetera. So it takes a while. But the Chinese progress, if you ask me on the technical front has been, there are about 5 integrated producers in China. Out of them, 1 or 2 have -- are able to make electrodes, let's say, up to a certain size, let's say, I'll give you a best size up to 24 inches. But it is going to take time. It's -- if they were really want -- if they really make a true UHP product, they have to use 100% needle coke, take it through a certain process and then make a product which is equal to that of HEG or other world majors. And that is where they cannot fight on price. The fight comes when we are making different things. And if they are using other kind of raw materials or using them in a blended way or something, then they, of course, cannot make the same product. See, our target is to remain cost competitive. See these pressures will be there forever. But it's just a pricing pressure, not a technical pressure that, okay, they've made a product that we can't match up with on the quality point. So we have to make a good quality product and stay competitive in our costs. So there is going to be the mantra for the future.

Sure. And what is the type of -- what is the amount of quantum of capacity you're talking about in Chinese expansion in UHP space?

See, UHP space if I hazard a guess they were putting up a lot of, I don't know, brownfield, greenfield type of expansions. I don't know if, let's say -- let me put it this way that UHP capacity out of the total, I think, they have about -- among the 5 players itself about 6 lakh is what they have. But about, let's say, 80,000 to 100,000 tonnes capacity would be of UHP. But just having a UHP capacity doesn't mean nothing. They have to use the right raw materials, and they need to have the right technology.

Sure. Sure. You explained that earlier. And 1 last question is needle coke has always been supplied by very few concentrated guys. Is there any thoughts or any expansion or diversification in the supply source? Or that still remains concentrated? And is expected to remain concentrated in the next 3, 5 years?

3, 4 -- the major players in the industry, which is like the likes of Showa Denkos and Tokais, these 2 Japanese companies and GrafTech, which is an American company, see -- and HEG and our Indian competitor, all of these companies are using this standard, proven, year-long history of needle coke from these 3 suppliers. One of them is an American company, P66, and 2 of them are Japanese. Now when it comes to Chinese, they're using -- they have their own raw materials. They are putting up a lot of -- it's not needle coke as such. It's called -- it's coal tar based, it's pitch based needs needle coke. So in inner Mongolia, they are putting up a lot of these plants, which we -- these are going to make this needle coke or the substitute of petroleum-based needle coke from the coal tar based pitch coke route. So that they are going to do because if they have to service their own electrode -- to meet their own demand, they are ramping up their local supplies. But that's not petroleum-based needle coke. So these companies who have been in the business for 40, 50, 60 years, they are still using the proven suppliers. But yes, new capacities which are based out of coal tar based pitch coke are coming up in China.

The next question is from the line of Kirthi Jain from Sundaram Mutual Fund.

Yes. Sir, in terms of utilization, how you see our utilization expected to move over the next 1 or 2 quarters? We see -- given that the demand is improving for the steel sector, how you see our utilization moving up?

See, our expectation for the next 2 quarters, by the October to December quarter and Jan to March, we are expecting to be around 70%.

Okay. What is currently, sir? What was it in July to September quarter?

It was 74%. And prior to that it was 48%.

So you expect to come down, sir?

No, no. In total, we're expecting to go up. In the first half, it is 60%, and we're talking about 70% for the second half.

No, sir, from second quarter to third and fourth, sir?

Second quarter, third and fourth, that's very marginal actually. I'm just giving an estimate. It should be around 70%.

Okay. Okay. Sir, like any destocking or stocking will happen, sir, given that prices are expected to move, that relate volume ramp up? Anything do you see or your customers are ordering you more economic ordering quality?

See now one positive sign, which we have started to notice in the last 1 month is that the customers who were absolutely shy of just taking more than 3-month call, they are now slowly coming out of their insecurity and trying to take a 6-month call on prices. Earlier, they were just not hazarding I mean their purchase beyond 3 months, which actually means that the steel companies probably now have better visibility of demand. So they are able to -- they're trying to -- and they are in the position to take a call on tying up their raw materials for, let's say, 6 months. Now these are early indications, and I hope they'll sustain. Because once they -- once we come back to our earlier modules of at least being 6 months the 3 companies used to order 6 months at a time, we used to contract the needle coke 6 months at a time. So that is actually a much better, much more stable environment rather than just selling 3 months at a time for a product. Full cycle itself is 2 months. So there are positive indications. But then again, the current time and era which we are going through, this COVID thing is so confusing. Europe comes out of lockdown, then again goes back into lockdown. So a lot of things are happening. Let's see, let's hope, by March, I think the situation will become much more clear about steel demand of 2021, how COVID unfolds. Let's see.

Okay. Sir, in terms of our RM bucket, from, say, Jan to March to July to September, is the raw material price decline very substantial, sir?

Yes, it has, but it doesn't help us actually because still we are holding our stocks. You have seen NRV hit we took in the quarter closing March and, again, this -- the preceding quarter ending September. So we would have been very happy to get those raw materials at the prices of today and sell electrodes at prices of today, and we would have made good margins. So the same which we have -- I'm just repeating myself, it takes 2 months to make electrodes and 5 months to make the connecting pins. So it's really natural and all these raw material getting imported because always we have 2 months of the electrodes actually in the furnaces, 2 months of raw materials in our silos, 2 months on high feeds, and 2 months to finish inventory gone. So it's 8 months. So whenever there's fluctuation in the market prices, this is a minimum which we have to contend with. The reverse had happened when the prices had shot up. We had these raw materials in the shape of -- I mean we had this needle coke as raw material. We had work in progress. We had finished goods. So we have enjoyed that time. So it's kind of somewhat a reversal of what is happening.

So the current prices -- inventory -- suppose say, if you buy today's inventory, we would be getting the benefit in next year, April to June, correct, sir?

Yes, yes. By the time our -- majority of our inventory in -- which is in all forms, would have been consumed and sold.

Because when we see our inventory, it is like roughly INR 750 crores. Our quarterly consumption is roughly INR 250 crores of inventory. So it takes 3 quarters to consume the inventory, right, sir?

That's correct. 2 quarters for sure. And then the third quarter, what happens is that the -- we have already started buying a particular grade. So it becomes a blend actually. The new prices of needle coke starts flowing in and then some which is outgoing, and it's mix of blend actually. So -- but you've very rightly noticed, and yes, so that's why we are saying 2 quarters for sure. In the third quarter, the new prices will take over and, let's say, then we'll be selling 2/3 of the electrodes made out of needle coke at current prices and 1/3 of the -- out of the inventory. So that will be the return to profitability.

Sir, my last question is, sir, given that in one of the -- to earlier one of the participant, you told that a large capacities are being created in Chinese markets, and government is looking for self reliance for the resources. Sir, have we or another industry -- along with our industry partners, have we gone and -- go for some antidumping relief or something, sir?

No. Antidumping relief on electrodes, which are coming from China to India?

Yes, yes, yes, sir. Yes, sir.

So far, our answer is no because when the electrodes were tight -- very tight in India, we were actually supporting the steel industry in India, and we volunteered and said, okay, these are very trying times and we supported the removal of antidumping with the hope that actually Chinese will stop this. But if they -- let's say, we'll watch this situation for another 6 months. And if they continue to do so, then at the appropriate time we will do that.

But sir, you know the government process, sir. It takes its own time and again then the injury will -- to us and the industry will be very high, sir.

That's right.

I mean once they study the -- once they start the investigation process, then investigation will go on for a year or 2, then outcome comes and then it will be very long. So shouldn't we try now itself, sir? [Technical Difficulty]