HEG Limited (HEG) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to HEG Limited Q2 FY '22 Earnings Conference Call. [Operator Instructions]. Please note, 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. It's my pleasure to welcome you on behalf of HEG Limited and SKP Securities to this financial results conference call with the leadership team at HEG Limited. We have with us Mr. Manish Gulati, Executive Director; Mr. Om Prakash Ajmera, Group CFO; and Mr. Gulshan Sakhuja, CFO. We'll have the opening remarks from Mr. Gulati, followed by a Q&A session. Over to you, Mr. Gulati. Thank you.

Yes. Friends, good afternoon, and welcome to our Q2 financial results call for the year '21/'22. As you can see, this quarter's profits were higher than the previous quarters and among the best in the industry. Thanks to strong global steel demand, world's crude steel output increased by 7.9% in the first 9 months of this calendar year, including China. While steel production in the rest of the world, excluding China, increased by 15.5%. If we compare China steel production of quarter 2 with quarter 1, there has been a steep decline in steel production from 292 million metric tons level to 244 million tons, which is 49 million metric tons lower. This is due to the drive to lower carbon emission levels. And moreover, from November, they will be having winter cuts where they are supposed to be cutting 30% of their production. This will result in reduced Chinese steel exports, enabling the rest of the world to make more steel. As you know, 47% to 48% of which is from the electric arc furnace route where graphite electrodes are used. In fact, if you look at the monthly production of China, the September was probably the lowest monthly production in 33 years, and October registered even 9% lower than September. So coming to our country, Indian crude steel production increased by 23.3% for the 9 months, Jan to September, this year compared to the previous year. Despite the second wave of COVID-19, Indian steel industry performed exceptionally well in the last 2, 3 quarters with very high capacity utilization and record margins. According to WSA's latest short-range outlook, steel demand would expand by 4.5% in 2021, reaching 1,855 million metric tons, up from 0.1% growth in 2020. And further, steel demand is expected to increase by 2.2% to 1,896 million metric tons in 2022. In comparison with the last quarter's results, HEG's performance this quarter was much stronger, supported by improved global demand for graphite electrodes and firming up of prices. In Q2 FY '21, '22, electrode prices improved for both UHP and non-UHP grades, and we expect them to keep strengthening in the following quarters. Our high cost inventory of electrodes as well as that -- needle coke made electrodes from high quality -- high cost coke have all been liquidated. As we talk, the needle coke costs are also rising in tandem with electrode prices and the scarcity of needle coke due to increased demand could keep supply tight for the foreseeable future. Our online capacity expansion from 80,000 tons to 100,000 tons is in full swing, and we hope to be in the market with these new products by end 2022 or early 2023. This will bring our capacity under one roof to 100,000 metric tons, which is almost 40% more than the next largest plant. With our 4 decades of experience in business, we expect to be a supplier of choice to our global and Indian customers. And with this, I will now hand over the floor to our CFO, Mr. Gulshan Sakhuja, to take you through all the financial numbers, and then we'll be very happy to answer any queries that you have. Over to Gulshan.

Yes. Thank you, sir. Good afternoon, friends. I will now briefly take you through the company's operating and financial performance for the quarter and half year ended 30th September 2021. For the quarter ended September 2021, HEG recorded a revenue from operation of INR 518 crores as against INR 414 crore in the previous quarter and INR 323 crores in the corresponding quarter of the last financial year. Revenue for the quarter saw an increase of 25% on a Q-on-Q basis, while it witnessed an increase of 60% in comparison to the corresponding quarter of the last financial year. The upstream in the prices have led to the encouragement in the performance of the quarter. During the quarter ended 30th September 2021, our company has delivered EBITDA, including other income of the INR 167 crores in the quarter as against INR 94 crore. The company recorded a net profit after tax of INR 1.3 crores in the quarter as against INR 56 crores in the previous quarter and against a loss of INR 34 crores in the corresponding quarter of last financial year. Further, during the quarter ended 30th September 2021, the rate and the other guidance have been modified under the remission of duties and taxes on exported product scheme, while notification dated 17th of August 2021. Accordingly, the company has accrued the benefits amounting to INR 4.85 crores under the aforesaid scheme on the eligible export sales for the period from Jan 1 to September 2021, out of which INR 3.24 crore pertains to the eligible export sales for the period from Jan 1 to June 30, 2021. Expansion plan, that is increasing the capacity from 80k to 100k is going on a full swing. There was a few months delay in part due to COVID, and we expect the extension project to be completed in the quarter, October to December '22, and we will be ready with the commercial production from early 2023. The company is a long-term debt-free and having a treasury size of nearly INR 1,500 crore as on 30th September, yielding an average return of approximately 5.5% per annum. Now we would like to address any question or queries you have in your mind. Thank you.

[Operator Instructions] We have a first question from the line of Pritesh Chheda from Lucky Investment Managers.

Sir, if you could tell, what is the capacity utilization in this quarter from that 80,000 ton?

90%. 90%, it has been for Q1 as well as similar for Q2.

Okay. So sir, I was just doing the math because I was actually doing at 100% only. We are at about, let's say, $1,000 EBITDA-type number. We have this fond memory of this industry, even recording for a few quarters in excess of $5,000, not now, but in that golden period of '18. Right? I just wanted to understand the dynamics of the industry then for recording those kinds of EBITDA and dynamics of the industry now? And do you see upside to this $1,000, $1,200 EBITDA, which you're recording? And how has the business working changed because that was a phase where we gained on prices with stable needle coke. Then came a phase where we booked all the needle coke. So there was a phase of operational losses. And now how, in this cycle, is the business being done? So if you could help us understand this part.

Yes, sure. Let me distinguish between those times and these times. In those times, you would recall, in early '17, the preceding 6 years were actually quite bad for the industry where margins were under pressure and there was excess supply in the market and less demand due to which about six major plants had closed down in the western world. So by the time we came to early 2017, the demand and supply of graphite industries were all quite balanced, and then came a sudden shocker from the Chinese side that they put an immediate plant down on the polluting steel industry, the blast furnaces, et cetera. And their steel exposed to rest of the world declined from a level of 120 million metric ton, and within 2 years, there was at a level of 60 million metric tons. So that's a huge number. And just to emphasize what that number is, Indian total steel production is 112 million metric ton. So suddenly, a 60 million metric tons going out of the market, actually made the rest of the world make more steel. And rest of the world makes 48% of the steel with electrical arc furnace route. So there was a certain spurt in the demand of graphite electrodes. That came so sudden that the graphite industry was not ready to cope up with that. So by the time -- I mean, everybody turned out extra production incrementally. By the time, the market was on fire. See, for a steel company -- and it was just 3% of the cost. So nobody wants to take the risk of losing out of their steel production just for electrodes. So everybody tried to -- in the later months, everybody tried to stock up more than what they needed, which is -- and a company, let's say, in Middle East, a company who was happy with working with 2 months of physical stock of the graphite electrodes at their plant just because the reason they doesn't have any electric plants, suddenly wanted to give 6 months. So -- and everybody stocked more and more and more. So there was a crisis in the market and the prices shot up like anything, from a level of, let's say, $2,500 to a level of $15,000 happened in a matter of just 2, 3 quarters and everybody overbought. So there was a period of correction which followed later. And then by the time before the inventories got over, the COVID thing struck. So the inventories took a little more time to liquidate. So there was so much of excess material in the supply chain where it took a while, almost 1.5 years or 2 years, for that to correct. And that is what you saw in our results also that we had 2 bad years or another 6 bad quarters, trying to live with those high-cost inventories, revaluing them. Now the times are quite different than before. Now the times are such that we are getting a real demand from the world after all these corrections, after the -- there's no excess inventories of electrodes, neither with customers or with manufacturers. Now it's a more stable regime that we are actually catering to the real demand coming in the world, whatever 2%, 3% electric arc furnace is growing. Also in the past 2, 3 years, the clampdown on carbon emissions is increasing more and more. And China still continues to be very serious about it. I mean, as I said in my opening remarks, the September monthly production of China is the lowest in 33 years. So this is like making history because they are truly clamping down on their production. What will be the benefit of this for the other rest of the world is that the steel gets consumed domestically, so they won't have steel to export. In fact, they're discouraging export by taking out the VAT and even thinking of putting the export duty on some of the grades of steel they export. So that bodes well for the rest of the world because rest of world can make more steel through electric arc furnace. Also, in China, they still continue to give emphasis on more and more electric arc furnace steel production, which is right now at a level of, let's say, 12%. And we expect in 2, 3 years, 3, 4 years maybe, it has to go to a level of 20%. And anyway, the scrap generation in China is also increasing. So these times are different than those times because those came a bit too sudden with industry got -- this is more stable. Now what -- this is a much better scenario than all the graphics companies, like ours, they are all working, all have almost reached a level of 90% capacity utilizations. So this is more stable than before, and prices are firming up quarter by quarter. That's how I look at it.

Okay. But as the industry of electro supplier now kept up with the pace of supply additional capacity? Or there is no additional capacity?

In the western world -- see, right now, as I just said that we -- I think all of the steel and graphite industry is already at a level of 90%. So we are doing an expansion of, let's say, another 20,000 tons. There is no other capacity announcement, which has come by -- other than China. China does keep -- they have lot of graphite companies making on mainly non-UHP electrodes. So they are there. But the supply tightness has now started to happen again among the graphite people in the western world.

Okay. And the format of doing business earlier, we had to book needle coke for a slightly longer supply, and hence, we saw also that 1 year and even in this call, you first mentioned that you exhausted the whole price needle coke. Last call also you mentioned, right?

Yes.

So now how does this business work? We have a more back-to-back way of pricing needle coke and pricing electrode that is a 3 monthly basis, when there is a spread always in mind, is that the way of doing? Or we still have to do -- go the old way?

No, we are now -- electrode people as well as the needle coke people are working quarter-by-quarter. If I have a customer asking for, let's say, yearly price, I'm unable to give a yearly price. So I just count what I have in stock, what is in the transit, what I have booked. So I always know our cost. So we are booking business quarter-by-quarter, and needle coke is also available quarter-by-quarter. But we always know our costs. We know the spread.

Okay. Can you comment on the spread now, what was the running?

No, you can -- it's not difficult for you to make some rough back of the envelope calculation, but I will not, I mean, given a number, please, because our transcripts are becoming easily available and then you know...

No problem, sir. But do you think that the spread will be more consistent now, unlike last time which went through haywire?

Yes. Yes.

Because it's all back-to-back...

This is what I completely believe that the spread in -- at least, in the next 2 quarters, which I can foresee, where we have an order book also and we know what are the price or maybe -- the spread should be consistent. But again, I'm talking only 2, 3 quarters ahead, not more than that.

So you see an upside to the $1,000 EBITDA, which is reported $1,000 plus EBITDA, which is reported in this quarter basically?

No, I will not say in dollar terms. I would rather say the margins, which you are seeing are going to -- you will see similar margins in the next 2, 3 quarters, reason being that all the costs are simultaneously going up. It's not only about needle coke. It's about pitches, it's about metallurgical coke, it's about freights, fuel, everything. All the costs are going up. And having said that, if we say that we are able to have -- maybe we expect similar margins. That means at least we are able to take care of all the incremental costs from all of the materials.

Okay. And sir, this 80,000 ton capacity, you can use at -- 80,000 higher than 80,000 or lower than 80,000?

See, as I said, this 80,000 capacity, we have -- once we reach 90,000 -- 80,000 is under certain conditions that we use -- I mean, we make certain products, certain types of products. It's like an ideal thing. It's like a nameplate capacity. It's like saying a car would have an average of such and such under certain such conditions. Of course, 80,000 is the real capacity we have. But when we work with different grades, different sizes catering to all kinds of demand. Usually, 90%, 92%, and that you'll probably see with every graphite company.

So you're saying about 90% to 92% of the rated capacity is what we use?

If you can stretch it to -- provided you're taking care of all the variables of the product mix. See, I have a product mix. It's not ideal to me. If I were -- if I would have the right product mix, exactly the sizes I want to make. And this happens because globally market also is like that. We have the electric arc furnace. We are also making some sizes for the needle furnace for our years old customers who still want buy the small size electrodes from us. So it's -- but once you have a product mix which is ideal, of course, it is possible.

Okay. So I'll just clarify. I'm confused here. You can operate at 90% to 92% comfortably, but even 100% utilization, which is generating a 80,000-ton output is possible. That's how you're putting, right?

It is possible, but it has certain fine print to it that I need to be making certain sizes more than the others. But if you want to cater to the market, your customers -- your loyal customers who have been with you for 25, 30 years, I cannot choose to make the sizes I want to because of plant capacity.

Which means you are running at optimal capacity as of now?

We can say that. 90%, maybe we stretch it to 92%, but that's where the ideal situation comes in.

[Operator Instructions] We have next question from the line of Sonali Salgaonkar from Jefferies.

Sir, my first question is regarding China. Last quarter, Q2, we saw power cuts in China. How do you see the entire situation evolving, and also, impact impacting our demand versus pricing in the other global countries?

See, what is happening in China, Sonali, you guys would know better than us. It's all in a state of turmoil. How it impacts HEG, we'll just talk about graphite and HEG. We are not supplying to China. All we are worried about, all we keep tracking is, what if China will effect to the rest of the world? Like, how much steel are they exporting? How much electrode are they exporting or importing that also. That's what we care about. Per se, we don't have any customers in China as such.

Right, sir. So I was asking from the indirect impact point of view. So for example, if the EAS production in China starts scaling down due to power cuts, how do you see the supply situation evolving in graphite electrodes?

See, right now, it is actually otherwise that we are seeing lot of inquiries coming in from rest of the world for non-UHP. They're asking for non-UHP. So that somehow -- if you talk about electrical power cuts, then their graphite industry is impacted more than the electric arc furnace industry because graphite is very power intensive. So in fact, it is actually working out to be otherwise. So the power cuts are hurting the graphite industry also, other than the electric arc furnace.

Got it, sir. Sir, second question is regarding the demand. How are you witnessing the demand scenario in the rest of the world, especially in Europe or Middle East or U.S.? And what is the current situation of the inventory? Are we at near normal inventory right now?

Sonali, I'm answering the second question first. We are working at actually record low levels of inventory. We do not -- I mean, let me not give a number, but yes, it's less than normal. I mean, the order book -- the demand is good. We are seeing demand from U.S., from Europe, from Southeast Asia. Virtually everywhere, globally, steel industry is doing well. And you can see the margins for steel industry in India as well as globally. Our inventory levels are pretty sized.

Got it. Got it. My third question is on the pricing. I understand you do not disclose the absolute pricing, but would you be able to articulate the quantum of price increase that we had in Q2 and how much do you foresee in the coming quarters? Just an approximate estimate would also do, sir?

Yes, that is what I can do. Let's say, Q2 versus Q1, let's say -- I'm just giving ballpark figures, we're talking in terms of 20% price increase Q2 over Q1. Going forward, we are able to see 8% to 10% price increases quarter by quarter.

Correct, sir. So 8% to 10% in Q3 over Q2. Is that sir?

Yes. Yes. And Q4 over Q3.

Got it. Got it. Sir, and my next question is regarding the capacity utilization. You did mention 90% utilization this quarter. Sir, how much was it last year same quarter? And what is it currently? Even currently, we are at 90-plus percent as we speak in November?

Yes. Yes. We are consistently at 90%, right, from the last quarter of last year. So since then, we have been at 90% level. And for the next Q3 and Q4 also, we expect to be at 90%.

Got it. And how much was the utilization same quarter last year?

Same quarter last year was 70%, 70%...

Yes, approximately 70%.

70% for the last year.

[Operator Instructions] We have the next question from the line of Veeral Gandhi from Ninety One.

I've got 3 questions. The first is about coal. So I had read that, in October, many power plants in India had less than 8 days of supply. What were the impact on your production if there are -- there is load shedding? And do you have anything in place to mitigate the risks around that?

Okay. So let me answer this for you. See, there was lot of news everywhere that India is working with like 4 days of stock, 3 days of stock. But later, I mean, it was -- we didn't see the impact anywhere. I mean, there were no load shedding, et cetera. And I think Coal India has done a wonderful job by ramping up production. That is why I think the government prevailed upon -- Coal India had to push their own domestic supplies. So, so far, as we talk, we didn't see any kind of load shedding, not to the industry, not to residential. So I mean, that's about it. And the way it has been proceeding since the last 1 month, the shrill of this coal shortage has gone down and industry is working normally.

Do you get all your power from the grid? Or do you have your own capture power plants?

We have capture power plants, which are also coal-based, but we're not running them now for the past 1 year. We are using all our power. We have been -- we have a 70-megawatt connection. And we are taking all the power from the grid, from the state electricity board, like we say it in India.

Okay. All right. And the second question was, I saw that the spot price for electrodes in China fell from May this year to the end of September and then rose sharply from that point on. Do you have any thoughts on what caused that movement?

Sorry, I didn't get the last few words. You said -- I heard about China, that prices shooting up after September '20. What is it you wanted to ask?

What caused that -- what caused the fall from May to September? So there's a fall in the spot price from May to September. And then September, it shot up very sharply back to the previous highs. I mean, it was quite an interesting dynamic. And I just -- I would -- if you have any clue as to what caused that, that would be helpful?

Really, the way Chinese have been working is demand and supply is very short term. You see more spikes from their side. So I mean, I really don't know why they had to go down to those crazy price levels in '20s. And also, I would -- you can relate it to the steel industry capacity utilization and steel demand also. From October '20, you are seeing a consistently rise in production of steel companies and improving EBITDAs. So that is the time where the internal period you are mentioning of April to September '20, even the steel industry was not doing as good. Steel industry started to pick up only after October '20.

Okay. And the last question I had was, I'd read about the use of graphite electrodes in electric vehicle batteries. There's a Chinese company [indiscernible] that produces this product. To what extent can production of electrodes for electric arc furnaces be converted to an electric vehicle battery? Or are they entirely separate markets?

These are separate markets, separate products. So graphite electrode, the primary use of that is in steel melting. The generic is graphite. So what lithium battery they're using is an anode. In a cell, there is an anode. And anode is nothing but a graphite powder. Yes, it is graphite, but it is processed differently. And anode can be made from 2, 3, 4 precursors, like a natural mine graphite, like a pitch coke. And so these are 2 -- sometimes people do mix the 2 things that probably is the same thing, but it is actually not the same thing. But yes, generic is graphite, but that anode, that process is very different. That product is very different from the graphite electrodes, which are used by steel companies.

[Operator Instructions] We have next question from the line of Manish Sonthalia from Motilal Oswal Asset Management.

Two questions. What is the situation of our Iranian exports? And second is, if domestic production in China steel is coming down, what are they doing with the graphite electrode capacity currently? Are they dumping it worldwide? Or how is the situation over there?

See, China, the main production, as you know, 88% is from the blast furnace side, and only 12% is from the electric arc furnace side. So when they're coming down actually. It's both -- the blast furnace side is impacted more than the electric arc furnace. Now what they are doing with their electrodes, I would say, right now, the way power cuts are going on, even their graphite in explode production is impacted. About your first question, the Iran thing, no, we are not exporting anything to Iran due to all these sanctions from the U.S. side. It was -- it used to be a very good market for us. But for the last 2 or rather 3 years, more than 3 years, they've been absolutely no mill supplies to Iran, but maybe if sanctions are lifted, we will -- might resume.

Okay. Just a follow-up on the graphite capacity in China. So with power cuts, et cetera, are you seeing really Chinese export of electrodes increasing over the last quarter or 2?

No. Rather -- no, not at all, rather I think I have a feeling from the market that their exports are actually coming down since the last quarter, the export of graphite electrodes. But maybe when the data emerges from China, we will have a look at it. But right now, the feel I have from the market because I'm in touch with customers on a daily basis. So it seems to me that more inquiries are coming to our side for the sizes which were earlier supplied for the non-UHP grade, which was earlier supplied by Chinese.

So customers are now preferring more of UHP as opposed to HP?

No, I didn't say that. It's not about UHP versus non-UHP. See, we also have a certain -- in our product mix, we also make about 30% non-UHP. So the customers -- our customers are aware that HEG also makes some non-UHP products. So even they're not getting supplied from China, they turn to HEG to ask if we have some availability. That's how I get a sense that, let's say, x, y or z customer who was not checking with us for the non-UHP, suddenly, they start checking with us or sending inquiries gives us an indication that probably they're unable to source it from China.

Okay. And just additional question. What is the price difference between, let's say, an HP and UHP for similar dia? I mean, just -- not the best number, but just for...

Actually, it varies year after year, quarter-by-quarter because both have different costs, in the sense, here, we have to use only needle coke. And for the non-UHP, we use Indian regular coke. So it depends upon their pricing and mostly non-HP is pricing is driven by the ES demand in the world and what our graphite industry is doing. Non-UHP is mainly -- pricing is mainly driven by how much supplies are coming out of China and their pricing. So accordingly, we have to price our products. So if you ask me strictly, what is the difference between the 2, then it varies. I wouldn't say...

Sir, what is the difference in prices for similar diameter. So it can give some idea about the demand-supply situation basically on the China side. If the gap has increased significantly? Or is it compressed? Or is it stable?

I mean, it varies on which point in time. Okay, if I have to answer this, let's say, if I have to answer this today, what is the difference between UHP and non-UHP, I would say anywhere between $1,500 to $2,000, something like that. But because they are 2 different products, actually, that -- they are replaceable. I mean, you cannot use non-UHP in place of a UHP.

No, I was just referring to the last cycle when we saw a very steep J-curve in graphite electrode prices. At that point in time, the UHP and the demand was so strong, the UHP and the non-UHP prices converged literally, literally converged.

Literally converged, correct. Absolutely...

Right now the gap is standing at $2,000.

Again, which point in time, 3 months later, you asked this question, I'll give a different...

At this given point in time. Currently -- currently as we speak?

Okay. If you are being so specific then let me hazard a more accurate guess to you. $1,000, I would say, $1,000, $1,500, not $1,500 to $2,000. $1,000 to $1,500.

[Operator Instructions] Your next question from the line of Ravikanth Aruna, an investor.

I'm Ravikanth speaking. I'm a retail investor. So I clearly got lesser knowledge in this area, but I did my research a little bit. So out of the points that you sourced, sir, what I would like to know is, you said there are curbs in China that the production -- with power cuts or whatever, the production of graphite electrodes and also the steel making has reduced. And then there is -- we all know that China is a big -- is one of the largest producer of the graphite source. So will that reduction in supply cause any imbalance or increase in demand in the rest of the world, which could -- I'm mean to say, the other regions like Europe, U.S. and the other Asian countries, this could fulfill the demand for the graphite electrodes?

See what we are seeing -- I was mentioning, we are seeing inquiries coming in for non-UHP electrodes also. UHP, of course, they are coming. But non-UHP also from places like Europe. Europe has recently announced the antidumping duty against Chinese. There's one reason. But even in other parts of the world, we are seeing more inquiries coming for non-UHP also, those customers who are probably taking from Chinese earlier.

[Operator Instructions] Thank you. Ladies and gentlemen, that was the last question. I'd now like to hand the conference over to Mr. Gulati for closing comments. Over to you, sir.

Yes. Thank you so much, friends, for attending this conference call. And we hope that the -- and the times to come will be better than this and the demand for steel and electrodes will continue to grow. We look forward to meeting you in our next conference call. Thank you so much.

Thank you.

Thank you very much, sir. Ladies and gentlemen, on behalf of SKP Securities Limited, that concludes this conference. Thank you for joining with us, and you may now disconnect your lines.