Graphite India - Sequential improvement seen; upgrade to Buy - Centrum

We upgrade Graphite India (GIL) to buy from hold earlier post Q1FY14 results which were above our expectations at operational level with EBITDA at Rs569mn (up ~16% QoQ and 16% over our est.) on account of lower costs for power & fuel, stores and other expenses. We like the stock on account of the strong balance sheet with good dividend yield and post the recent sharp fall in stock price, we find current valuations attractive. We see demand pressure continuing in the near future for graphite electrodes due to low steel production growth globally but see realizations supported by lower rupee mitigating the overall impact on earnings. We revise our EBITDA estimates downwards for FY14E/15E by 4.7%/7.1% factoring in lower volumes.

Electrode volumes flat YoY due to lower demand: Capacity utilization (inlc. 20ktpa new capacity) stood at 67% implying almost flat YoY electrode volumes but was better than our expectations of 62%. Lower global demand due to slow steel production growth (~2%YoY higher in H1CY13) led to expanded capacity not being fully utilized. Electrode realizations remained subdued but were positively impacted in rupee terms by sharp rupee depreciation.

EBITDA margin improves but inventory increases: EBITDA margin improved to 14.4% during the quarter on account of lower other expenses and power & fuel costs and negative expense for inventory build up.

Outlook - Earnings to be supported by lower debt and depreciating rupee: Lacklustre demand from steelmakers globally has put pressure on graphite electrode demand and price for electrodes has seen a downward bias in US$ terms but the same has been mitigated to a large extent by sharp rupee depreciation, which we believe would support revenues and earnings for GIL. Needle coke has been contracted 15-18% lower for different grades and total gross debt has been reduced to Rs4bn from Rs6bn by the end of Q1FY14 thus reducing costs. Management continues to focus on achieving economies of scale from its expansion at Durgapur for achieving further cost optimization. We see pressure on volumes and realizations due to low demand and reduce our EBITDA estimates by 4.7%/7.1% for FY14E/15E but still expect adj. PAT to grow by ~20%/15% for FY14E/15E. We expect electrode volumes of 56000/60000 tonne from domestic operations in FY14E/15E.

Valuations - Upgrade to Buy: We like the strong balance sheet and good dividend yield of the company. We value the company at an average of 5.5x FY14E EV/EBITDA and 9x FY14E P/E and arrive at a target price of Rs80. Upgrade to Buy from Hold on account of steep fall in stock price and valuations recently. Key Risks are fall in electrode prices and lower than expected electrode volumes.

Source : Equity Bulls

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