After posting up to 900% surge in Q2 net, these 2 stocks can add to their 3-year-long 1,000% rally

Their stock valuations may look a bit inflated, but analysts are latching on to them -- of course, with some rationale.

Graphite electrode majors HEG Ltd and Graphite India are making the numbers speak for themselves as both posted a manifold rise in bottom line as well as top line for the quarter through September.

The result: The stocks have rallied over 1,000 per cent in just a matter of 3 years!

The fact of the matter is fortunes of the graphite electrode sector are closely linked to electric arc furnace (EAF) method of steelmaking. Globally, the percentage of crude steel produced through the EAF route has gone up to 28 per cent in 2017, from 26 per cent in 2016.

“We expect the share of the EAF route in overall steelmaking to increase further, thereby supporting global graphite electrode demand,” ICICIdirect said.

Q2 results and outlook
For July-September, Graphite India's net profit zoomed as much as 913 per cent year-on-year to Rs 912 crore on the back of healthy realisations while net sales grew 335 per cent.

Similarly, HEG Ltd notched up a gain of 682 per cent and 338 per cent YoY gain net profit and sales, respectively, during the said quarter. Bottom line shot up to Rs 888.90 crore in the September quarter, from Rs 113.70 crore a year ago.

In specific terms, share prices of Graphite India and HEG have surged 1,156 per cent and 2,426 per cent, respectively, in the last three years till November 30.

“We continue to value HEG at 10x FY20E EPS of Rs 575, thereby arriving at a target price of Rs 5,750. In addition to healthy demand prospects, the capacity expansion announced by HEG will provide healthy revenue visibility over a medium term,” ICICIdirect said in a report.

The HEG board has recently approved a buyback of 3.41 per cent of the company’s shares worth of Rs 750 crore. The firm has set the buyback price at Rs 5,500 per share. The stock hit Rs 4182.50 on November 30.

HEG has also announced expansion of its graphite electrode capacity to 100,000 tpa (tonnes per annum) from 80,000 tpa.

“The additional 20,000 tpa will be at the cost of Rs 1,200 crore and is likely to be financed via internal accruals and debt, if required. The fresh capacity is likely to go on stream within 30-36 months," HEG said.

The company is operating at a capacity of 85-90 per cent.

Centrum Broking has a ‘Hold’ rating on Graphite India with a target price of Rs 1,110. “We continue to remain upbeat on the electrode industry remaining in an upcycle and expect extremely strong earnings trajectory for the company in the next few years. The key downside risk is margin pressure due to raw material volatility while upside risk is a continuation of high spreads into FY20E/21E as that of FY19E,” the brokerage house said.

ICICIdirect has ‘Buy’ on Graphite India with a target price of Rs 1,400.

Opportunities and threats
The management is also confident of the future of graphite electrode theme.

“The global demand for graphite electrodes is robust as the steel industry worldwide shifts towards the more efficient electric arc furnace route. With China shutting down excessively polluting steel Production by BOF/induction furnace routes, the very environment friendly EAF route is gaining market share, resulting in a robust demand for our products. Domestically, with our steel industry consolidating and newer capacities also opting for EAF route, the demand for our product within India is also likely to grow in coming years,” Ravi Jhunjhunwala, CMD and CEO, HEG, in a statement said.

Restarting of Chinese capacity is the biggest threat to the industry. “The biggest threat to the supply is that one day China decides to go back and start the blast furnaces which are three times more polluting than electric arc furnace,” Jhunjhunwala said in an earnings call in November.

MF holdings
Money managers are also looking bullish on Graphite India and HEG.

As many as five mutual funds were holding over 1 per cent stake in Graphite India as of October 31. The list included BNP Paribas Asset Management, BOI AXA Investment Managers, HSBC Global Asset Management (India), L&T Investment Management and Principal Asset Management.

BOI AXA Investment Managers, Motilal Oswal Asset Management and L&T Investment Management were holding over 1 per cent stake in HEG as of October.

The latest holding figures of mutual funds for November are yet to come.