FROM “FLAVOURS” TO “OUT OF FAVOUR”

Graphite India and HEG, for later half of 2017 and almost the entire of 2018 were on a high, hitting the 5% UC and new highs had become the norm. There was an almost mad scramble to get these stocks and people were willing to buy at levels of record highs. Then suddenly, as it happens whenever there is such a mad fervor, the stocks started climbing down.

Graphite India which had hit a record high of Rs.1126 on 14^th August 2018, went on to hit a new low at Rs.308.70 on 16^th May, 2019. HEG too scaled a new lifetime high on 10^th Oct at Rs.4950 and on 16^th May, hit a new low at Rs.1542.

So what happened? From being the darling of the bourses, no one seems to want them any more. When and how did these two, the flavor of 2018 get so much out of favor?

First, why were they so celebrated and sought after? For two years now, 2017 and 2018, the outlook was projected to be extremely bullish and the sector was on a fast track of growth. This optimism came from, who else, China.

Both the companies make graphite electrodes which are key components of electric arc furnaces that turn scrap into steel. 

The Chinese banned usage of induction furnaces and these were expected to be replaced by Electric Arc Furnaces (EAFs) and Ladle furnaces for steel making. And the biggest beneficiary of this was projected to be graphite electrode makers as they are used extensively in EAFs. An additional demand of 2,75,000 mmt, up from 52 mmt in 2016 was expected to keep the graphite electrode makers really super busy.

With these reports coming in from industry experts, brokerage houses went berserk, giving wind to this already raging fire. Foreign brokerage Macquire put out a report saying said that the uptick in demand for graphite electrodes was not just a tick, one-time thing but marked a structural shift upwards. It expected price of electrode and needle coke to remain firm and stay strong for three years at least. This was extremely bullish for Indian electrode makers as they have a 22% global market share, which is no small fry!

Macquire gave Graphite India a price target of Rs.1260 and HEG of Rs.4810. There was another such bullish report from BofAML. For HEG, the target price was Rs.6700 and Graphite India at Rs.1550. This was in 2018.

Thus bullish reports from industry experts and then brokerage houses fanning it further pushed the stocks to the stratosphere.

So what has changed in 2019?

Blame this also on China. Its largest graphite electrode maker, which was on the ebb for the last 7 years is planning to resume production at full throttle. Its annual production is expected to be 30,000 tonnes. There is a report put out by Citi which said that Chinese production is expected to rise by 40% to 800 kilo tonnes in 2019-20, with estimated a capacity addition of 465 kilotonne (kt) in 2019, 310 kt in 2020 and 185 kt in 2021. With the sector looking at a virtual supply glut, naturally, the prices have fallen. Prices have fallen 23% since Jan 2019 and currently some companies are negotiating prices for July-Dec 2019 at 10% discount to the current rates.

This China factor apart, in Sept 2018, India ended anti-dumping duties on graphite electrodes imported from China. Thus there are now higher imports from China while the price of graphite electrodes have been hit by weakness in steel prices. Compounding the problem is the rising price of needle coke, a key raw material used to make graphite electrodes, which is further culling the margins.

Additionally, both companies used to export 8-10% cumulatively to Iran but that stopped from Dec’18, following the US sanctions.

Following these unexpected global circumstances, Macquire, in its 17^th Jan report, cut price targets for HEG by 21% and Graphite India by 24%.

We do not write off these two stocks. They are in a correction phase after a long bullish run. Wait for the price to settle and then take a call as both companies remain fundamentally strong. Two years from now, maybe the story for the sector will change once again….