HEG Limited (HEG) Earnings Call Transcript & Summary

Good day, ladies and gentlemen. Welcome to the HEG Limited Q1 FY '22 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Agrawal, Head Institutional Equities at SKP Securities Limited. Thank you, and over to you, sir.

Good afternoon, ladies and gentlemen. It is my pleasure to welcome you on behalf of HEG Limited and SKP Securities to the financial results conference call with the leadership team at HEG Limited. We have with us Mr. Ravi Jhunjhunwala, Chairman, Managing Director and CEO of HEG Limited; along with his colleagues, Mr. Manish Gulati, Executive Director; Mr. Om Prakash Ajmera, Group CFO; and Mr. Gulshan Kumar Sakhuja, CFO. We'll have the opening remarks from Mr. Jhunjhunwala followed by a Q&A session. Over to you, Mr. Jhunjhunwala. Thank you.

Good afternoon, Navin. And good afternoon, friends, and welcome to our Q1 financial year 2020 con call. In comparison with last quarter's results, HEG's performance this quarter was stronger supported by improved global steel sector growth, which resulted in increase in demand for graphite electrodes and firming up our prices. As for the recent data released by World Steel Association, global crude steel production between January, June surpassed a little over 1,000 million ton for the calendar year '21 for 6 months, which was up by a strong 14% compared to 2020. Steel production ex China was up about 18%, and while China increased by 11% compared to 2020 trend. This is probably after a very, very long time that the rest of the world steel production has grown more than China. Just this morning, because the July data of Chinese steel production, which shows a further fall of about 8% compared to June. Again, after a very long time that we see a reduction in Chinese steel production month on month. Chinese government continues to discourage export of steel to other parts of the world. To this effect, in addition to removing a 13% VAT debate for exports, which they have already implemented from first of July. They are seriously mulling over the proposal to put an export duty on steel exports. As you are aware, any reduction in exports of steel from China helps the other part of the rest of the world, which incidentally produces about 47% to 48% of its total steel through electric arc furnace, which is our customer base. The Chinese government continues to put in place stringent environmental measures to limit country's carbon emission levels, which is directly supporting electric arc furnace capacity to replace polluting blast furnace capacity. Electric arc furnace steel still constitutes only 12% of Chinese steel production, which is 2x of what it used to be in 2016, and which, as per the Chinese Government's announcement, it's likely to be around 20% by 2025. Again, this has to be seen in the backdrop where the rest of the world even today, produces about 47% of their steel through electric arc furnace. And especially in the U.S., we are seeing a very strong growth where between 12 million to 15 million tons of additional new electric arc furnaces are under construction and most of them are likely to be ready by end of next calendar year. Now coming to India. As per WSA, Indian crude steel production registered a growth of about 31% in the first 6 months, January, June, comparing with the same period last year when steel production was, obviously, at a record low level due to nationwide lockdown because of COVID. India continues to maintain its position as the second largest producer of steel in the world after China. Despite the second wave of COVID-19, the Indian steel industry performed exceptionally well and has been operating at a very high capacity utilization level and has yielded record margins in the last couple of quarters. Steel prices in India and worldwide are at record high levels and are expected to continue to remain strong, driven by robust demand and also driven by a reduction of Chinese steel exports with the rest of the world. In this backdrop, growth globally and global efforts to reduce carbon emissions, coupled with increased scrap generation in China. We believe that the electric arc furnace steel production in the world will grow at the CAGR of anywhere between 3% to 5% in the medium run, driving the ultra-high power electrode demand. The electrode prices improved for both UHP and non-UHP grades in Q1 '21-'22, and we expect them to strengthen in the coming quarters due to robust demand arising from the increased steel production through EAF. In fact, in the last quarter, we have seen a level in the first 6 months annual level of about 105 million tons of electric arc furnace production on a pro rata basis for the quarter, which is more or less what we had seen at the highest level of 2017/'18. Needle coke prices are also rising in line with the electrode prices. However, our entire old high-cost inventories, both for electrodes and needle cokes are totally over now, and we look forward to improve operating margins during the rest of the quarter for the current year. Trends are expansion to increase capacities from 80,000 tons to 100,000 tons is going on at full steam, and we are confident of completing it by end of '22 and be ready with commercial production from early 2023. We still increase our capacity to 100,000 tons under 1 roof, which would be around 35% to 40% higher than the next largest plant. And as you are aware, any capacity expansions even brownfield does take a very long time in our business. And until now, we have not heard anyone else announcing any capacity enhancements in the short term. I will now hand over the floor to CFO, Gulshan, to take you through the financial numbers, and then we'll all be very happy to answer any queries that you have. Over to Gulshan.

Thank you, sir. Good afternoon, friends. I will now briefly take you through the company's operating and financial performance for the quarter ended 30th June 2021. For the quarter ended June 2021, HEG recorded a revenue from operations of INR 414 CR averaging INR 380 crores in the previous quarter and INR 233 crores in the corresponding quarter of the last financial year. EBITDA, including other income, stood at INR 94 crores in the quarter as against INR 20 crores in the previous quarter and INR 35 crores in the corresponding quarter of the last financial year -- the company recorded a net profit after tax of INR 55.8 crores in the quarter as against a loss of INR 6.8 crores in the previous quarter and a profit of INR 10.76 crores in the corresponding quarter of the last financial year. Further, the company in accordance with the amended provisions of corporate social responsibility, which mandates incurring of 2% of the average profit of 3 financial years have incurred expenditure amounting to INR 6.15 crores during the quarter ended 30 June 2021 and INR 34.85 crores during the quarter ended 31 March 2021 and INR 41.86 crores during the financial year ended 31 March 2021, which has been included under the other expenses in the published results. The company is eligible for various export incentives on the export made. Central Government of India had announced a new scheme of remission of duties and deficit on export products, which has replaced the existing MEIS with effect 1 Jan 2021. As the rate under RODTEP have not been announced till date, the income on account of export incentives under the new scheme has not been recognized for the quarter ended 31st March 2021 and 30th June 2021. Now moving towards the expansion. Our Chairman has just said, same is going on in full swing. There was a few months delay that due to COVID, and we expect that expansion project to be completed in the quarter, October to December 2022, and we will be ready with the commercial production from early 2023. The company is a long-term debt free and having a previous size of approximately [ INR 1500 crores ] as on 30th June 2021. Now we would now like to address any questions or where you have in your mind. Thank you. Now over to you, Navin.

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

So my first question is, again, regarding to the global update in electrode sector. If you could just update us on the supply side. So you talked about the demand side. But on the supply side, especially the smaller players, which are mushroomed in China. What is the update on the supply on that front, sir?

You see, Sonali, while Manish will give you a detailed answer. I mean we have been explaining this in the past also that we do compete with China in about 30%, 35% of our production, which is called non-Ultra high power. But when it comes to the rest of our production, which is 65%, 70%, we still don't compete with them, and we don't see them in the world market where we are exporting our UHP. And again, even in the non-UHP where China is a player, there are several countries where there have been very substantial antidumping duties. And they have not been there. It's not a very new development. They have been there in some of these countries for a long time. U.S. has been having it for last maybe 5, 6 years. And the way information that EU has initiated the same very recently in the last 3, 4 months. So there again, and we all know the China plus 1 and the anti-China feeling that everybody has currently. So even in that sector, where we do compete with China, which is about 1/3 of our production, we see -- we don't see that rate really, very seriously. Manish, if you want to add anything?

Yes, sir. I just wanted to add here, sir that all the -- Sonali, all the Western producers, if you take the Chowanec and then the Graftech and the Tokai, none of them are increasing capacity. On the contrary, Chowanec just closed their plant in Mandideep and affecting their capacity to the extent of 40,000 tons. So the main Western producers which includes Chowanec, Graftech, the 2 small Japanese and our Indian competitors. None of them is increasing capacity. And because of which the capacity utilization because of increase in demand, which were about 65% as an industry, the Western liquid industry is now moving up to 80% -- more than 80%, around 82%, 83% is what is going to be the global electrode industry capacity utilization. And that is how you see the firming of prices because the demand is increasing and everybody's capacity utilization is going up. And once they reach their 80s levels, 80% level, the prices start to form up. And the other part, Chairman, Mr. Jhunjhunwala has already explained. But of course, there is a lot of talk about this in small electrode plants coming up in China, who will be using the coaltar-based page core. So we really don't see that as a threat to the main Western producers and also to us.

And as I just mentioned, China, while the rest of the world produced about 47% of its steel through EAF, until 4 years ago, China was at 6%, and now they've doubled to 12%, and they want to reach about 20% by 2025. And 6% going to 25% is almost like more than a 4x increase. And you have to keep that in mind when you're talking about 4x, you're talking about a country like China, where the percentages are very misleading, the base number is already so high, like 50 million tons of electric arc furnace, which they were doing about 4 years ago. It's currently at about 100 million, 110 million and this is likely to be 200 million. So they themselves will require a huge amount of electrodes for their own consumption. And again, most of it is non-UHP.

We just had Sonali Salgaonkar's line disconnected. I'll join her back.

Yes. Sir, my second question is regarding the pricing of electrodes. Sir, if you could help us with the approximate quantum of price increase that we have seen in Q1 FY '22?

Manish?

Sir, I would say it was somewhere between, if you ask a specific number, between 15% to 20% is what we have seen between Q4 and Q1.

Understand, sir. And going forward, we are optimistic about the outlook for this because of the demand centers opening up, right?

Yes. Yes.

Thirdly, on the needle coke, we mentioned that we have liquidated majority of our higher cost needle coke inventory in Q1. So going forward, should we expect to get the benefit of the lower cost inventory?

Yes. That's right. That will be helpful in improving the margins. Yes.

Understand. Sir, but the needle coke is it growing in tandem with the electrode, the pricing?

It is -- the prices still are enough electrode prices to protect the margins. But yes, they are also growing quarter-by-quarter as electrode prices improve quarter-by-quarter, the needle coke price are also increasing quarter-by-quarter. But since we are out of that high cost issue, which we were carrying for the last 6 quarters. So now at least we should have a decent operating margin covering after considering the hike in needle coke prices.

Got it, sir. Sir, what is the capacity utilized see in Q1 FY '22?

Now more than 85%.

Okay. And even right now, as we speak in July and August, it's still sustaining at 80% less level?

Yes. It still continues to be more than 85%.

Got it. Sir, lastly, our other nonoperating income has declined materially on a Y-o-Y basis almost half year-on-year. Sir, how should we look at it? And should we expect that to normalize over the coming quarters?

Yes, the Gulshan just take it over and explain.

Yes. Sonali, if you see this other income on quarter-on-quarter basis, it is coming INR 22 crore as at [ 25 ] in the last quarter. This is based on account of that if you see in the market scenario, the rate of interest is going down and resales that the income from the investment, the trading size that we have been maintaining in our books of accounts. That is also getting reduced over a period of time. [indiscernible] INR 25 crores to INR 22 crores, the reduction is on account of lower rate of interest on our treasury. This is on account of that ratio.

Sonali, you have to keep in mind this INR 1,200 crore expansion that we are doing, it's all from internal approvals. So obviously, as it comes to a close, we keep reducing the treasury.

Got it. Sir, last question from my side. Sir, you gave an update on the time lines of the CapEx. Any change in the expected outlay in FY '22. So I guess you had mentioned about of the INR 12 billion, about INR 5 billion to INR 6 billion outlay in FY '22 and the rest in FY '23 and '24. Is that -- are we maintaining this?

Yes. I think -- yes, yes. Yes, there's no change in the outlay.

[Operator Instructions] The next question is from the line of Saket Kapoor from Kapoor & Company.

Sir, firstly, sir, can you repeat the China production number, sir, month-on-month, which you articulated in your opening remarks for the month of June and July? The steel production number?

We got this data only this morning, which suggests a drop of about 8% steel production compared to June. This figure is for July, 8% below in July compared to June.

Month-on-month, 8% reduction, sir?

Yes. If you remember, if you have been tracking, I mean they impose certain restrictions, which commenced from first of July. They removed the VAT, 13% VAT on export of steel. So obviously, to that extent, the exports of steel must have come down. And secondly, they are also contemplating very seriously putting up an export duty. So going forward, we think that to the extent that their export will come down substantially, there will be some correction in their own production also. And again, to remind you, every drop of export of steel from China to rest of the world helps our industry tremendously because 47% of that steel is produced through the electric arc furnace in the rest of the world.

But if we take the entire China volume, what percentage is through the AF roof and how much is from the blast furnace?

So China in 2016 was only 5% against world's 47%. That is where they started focusing so much on the carbon emissions. I'm just taking out of the context, but it's a published data. So nothing to hide there. Blast furnace steel industry constitutes the single largest industry polluters in China. That 1 particular sector of blast furnace constitutes as much as 18% of industrial solutions in China. So if 1 particular industry is as much as 18% of pollution and the numbers in China are, let's say, same times of India or the whole world on 1 side and China on 1 side, at least on the steel. So that's created a lot of U.N. cry in China about the pollution. And that is where they took some very drastic steps by closing down about 150 million tons of blast furnaces in 2017/'18. And with the results, their exports practically came down to half from about 120 million tons to 55 million, 60 million tons. And as I said just now, any drop of Chinese steel outside of China helps the other part of the world to produce more steel. And they produce close to 50% through electric arc furnace. So that is how the electrode demand shot up 2, 3 years ago, and this is what we are seeing right now because now China is going 1 step ahead, and they have removed that refund of 13%. On top of that, there's a likelihood of putting up an export duty.

So current mix is 50% from EAF route and 50% from the blast furnace with the reduction in the blast furnace capacity, this is what we can...

The 47%, I'm talking about the rest of the world, not China. China, even today, is only 12%, 13%, which is likely to go to 25% by 2025.

And the current demand is from the European steel manufacturer. There, I think the EAF route has the highest percent?

Yes, every -- all the rest of the world, minus China produces 47%. U.S. is about 70%, 75%. EU is about 40%, 45%. And the whole world is about 47%.

Right. And sir, this carbon emission part of the story, there is also some carbon tax that has been calculated in the steel trade in the European region, all these are the positive factors for the EAF route to gain traction.

Absolutely. And the carbon taxes are now coming in vogue and they'll become -- they're getting more and more expensive by the day.

Right, and these taxes are pertaining to the steel manufacturers that are coming with the blast furnace only or for the EAF route also, there are some percentage, I think?

You see, every industry has some pollution issues. We are really comparing blast furnace versus electric arc furnace. So it's a stated fact that for each ton of steel that you produce through the blast furnace we are polluting the atmosphere by about 4x. So the same ton of steel through electric arc furnace, let's say, if it is 1, the blast furnace is about 4.

Got it. Coming to our story now, our export mix is 65% is exported 35% is domestic. So domestically, I think so Tata BSL and SR Steel are there only 2 main buyers of EAF route electrodes or other players also?

No, in addition to these 2, you forgot the 3 generals, JSW, JSPL and JSL.

[Our country's] JSL from the stainless steel part of the [sector] So if the requirement of in steel manufacturing to the scrap route with JSL is doing stringent what -- how is the requirement defer from the same to go for carbon steel and stainless steel per ton requirement?

Manish, would you answer that?

Yes. See, stainless steel is about 1 million ton production. And we are talking about the India total production of more than 100 million tons. So stainless steel is a niche product. But the main demand of steel is from the carbon steel, which is used for construction. So that is where -- and also then again, automotive. Stainless steel is a very small portion. Even worldwide. I can tell you the worldwide capacity of stainless steel making is about 50 million tons and 1 million ton is in India, which is the general stainless and 1, 2 small things. So the main demand for graphite electrodes and all this comes from the non stainless steel. Stainless steel is a very small segment, just like special alloy steels are.

I was only looking for, what is the proportion required for -- in their steel making process?

See in their steel-making process, they have to use stainless steel scrap, while the others use of variety of the DRIs, normal carbon scrap, et cetera.

I'm talking about other electrode consumption in proportionate to stainless steel and the carbon steel. So if you could give me more specific...

Yes, sure, sure, sure. Sure. I can provide that. See, our -- if you -- let's say, about 10%, I would say, would both of our electrode business -- would come from the stainless steel, not only that we have some customers like general stainless in India. And we have a couple of customers, 1 in Spain, 1 in U.S. So we are catering to the stainless steel segment. But let's say, out of our total volumes, if I make a rough estimate, it would be 10% or less than 10%.

[Operator Instructions] We will take the question back from Mr. Saket Kapoor from Kapoor & Company.

Sir, I was coming to the raw material basket, sir. If we take the -- our raw material market, what percentage goes to the needle coke, sir. And if you could give the current environment for needle coke production and new capacities that are in the end and the geographies where they are expecting?

Can I answer this?

Yes.

See, if you look at the main needle coke suppliers in the world, which is a Mitsubishi, Sumitomo. So there is no increase on their side. What is happening is whenever you're listening about these increases in China. And in China, the coaltar based and not the petroleum based. So we have not seen any capacity expansions coming from the main needle coke suppliers, but there are coaltar-based pitch plants, coke plants coming up in China. And that is to support their own electrode industry because where are they going to get the coke from? So eventually, the petroleum-based needle coke is limited both by supply, by technology. And so the next best substitute or not exactly a substitute, but a poorer substitute is coaltar based pitch needle coke.

Sir, I didn't get the last point.

Okay. So I was saying that the main producers, the names I said, are not -- we have not heard from them doing any capacity additions. But whatever capacity the needle coke which you listen is coming from China. And I should specify all the plants which are coming up in China, barring the 3 companies, most of them are coaltar-based pitch needle coke. It's not petroleum-based needle coke which you can use for the higher diameters, the large diameter UHP electrodes. So what I'm saying is the capacity addition in needle pitch coke which is happening in China is to cater to their own increasing demand for electrodes. So they will be like a captive, they will be using those switch cokes for making graphite electrodes in China.

So with our expanded capacity, 20,000 tons, which will come up in next financial year, I think '23. So how is our raw material requirement going to get secured? And what is the ratio, sir, to create 1 ton of electrodes, how much of needle coke is required?

See, that is one-on-one. You can just assume because there are other things also which go into it. But eventually, if you take the raw material to the last finished products, the relationship is one-on-one. So 1 ton of needle coke makes 1 ton of electrodes. That is a thumb rule.

So for the expanded capacity, we will be securing that?

Yes, yes, we have the secure. Otherwise, how are we going to make electrodes. So it is a global marketplace. It is the same with every company. The way they will source it, the same way we will source it. And we have been 50 years -- going to be 50 years in the business. So we have ongoing relationship with all the needle coke suppliers in the world. So yes, it will be -- we don't see any problem, I mean just with everybody.

We take the next question from the line of Arvind Monie from Wellington Management.

Yes. So I read ST articles that talked about the announced capacity expansion in China. And there's been 2 blast furnace capacity announcements, while there's been 43 coal fire power plants in that coal-fired power plant capacity amounts to 35 million tons. When you think about, let's say, 2025 and growing capacity to, let's say, 20% to 25% is EAF, how do you see these shorter-term kind of data points? And how would you interpret them?

The long-term trend is very, very clearly towards electric arc furnaces because blast furnaces are such a big polluter and 18% of the pollution in China is coming only from the steel industry. So they have to control it. Now you, I'm sure you have seen this news, that China is trying to make only as much steel in 2021 as they have made in the last year. And they have made a proportion that 1.5 million tons should close down to have 1 million tons of new capacity. So these kind of data points which you are mentioning that you heard that some new blast furnaces have come up. And actually, I would call them an aberration. Because the way China works. I mean the way they still for years and years, they could have gradually gravitated towards electric arc fares, but we are now slowly doing it. And every year, they found more and more serious about it because it's becoming a problem for them. So this year, they will say they have put a climb down on production, that 2021 production should be equal to 2020. But if you see the first 7 months, Jan to July, they have grown by 8%, which clearly means that in the next 4 months, they have to actually climb down and bring it down. And July was the first month when actually they were 8% down. They were 8%. I would just -- if you have trusted integers, I can tell you that the July output, actually, they forced to be down by 8% versus June on production controls.

[Operator Instructions] The next question is from the line of Vishal Chandak from DAM Capital.

So my question is with respect to investment capital. Are the change in regulation regarding...