Graphite india - Initiating Coverage 28.04.10

Initiating Coverage | Capital Goods
April 28, 2010

Graphite India BUY
CMP Rs96
Riding the Rebound Target Price Rs117
Graphite India (GIL) is the world's fifth largest manufacturer of Graphite Electrodes, Investment Period 12 months
which is a key input in steel production through the electric arc furnace (EAF) route.
The Graphite Electrodes Industry is on a rebound, with EAF steel production expected Stock Info
to increase to 417.4 million metric tonne (mn mt) by CY2011E, a CAGR of 10.8% Sector Capital Goods
over CY2009-11E. We expect GIL to ride the uptrend and gain further Market Market Cap (Rs cr) 1,649
Share. At current levels, the stock is trading at 1.2x and 1.1x FY2011E and FY2012E
Beta 0.6
BV, respectively. We Initiate Coverage on the stock with a Buy recommendation
52 Week High / Low 103/31
Target Price
and Target Price of Rs117, valuing the business at 1.3x FY2012E Book Value Value
based on sustainable RoEs of 17.0% and growth rate of 5.0%. Avg Daily Volume 152904

GIL set to ride the Industry's rebound: The Graphite Electrodes industry is expected Face Value (Rs) 2

to grow faster, compared to EAF steel production over the next few years, as the BSE Sensex 17,380
de-stocking of graphite electrodes inventory on steel manufacturers' end, is expected Nifty 5,215
to reverse. Consequently, we expect Graphite Electrodes volumes to grow at 17.2%
Reuters Code GRPH.BO
CAGR over CY2009-11E. GIL, with a capacity expansion from 78,000mt/year to
Bloomberg Code GRIL@IN
88,500mt/year, to be completed by FY2012E, is well poised to reap the benefits of
this growth. We expect GIL’s Market Share to increase to 9.0% by FY2012E and Shareholding Pattern (%)
Top-line to grow at 16.1% CAGR over FY2010E-12E on the back of this expansion.
Promoters 63.6
Strong Labour Cost Advantage: GIL has strong labour cost advantages compared
Labour
MF / Banks / Indian FIs 14.3
to its global peers, as the other companies have their plants in locations where
labour costs are significantly higher compared to India. The largest global player, FII / NRIs / OCBs 8.1
SGL Carbon SE, has plants located mainly across Europe and North America. Indian Public / Others 14.0
GrafTech Ltd, world’s second largest player, has plants located in France, Spain,
South Africa, Brazil and Mexico. In FY2009, GIL's Employee cost was 9% of Sales, Abs. (%) 3m 1yr 3yr
whereas it was almost 23% (CY2008) for SGL. Historically, GIL has passed on a Sensex 6.6 58.0 25.0
part of this advantage in order to gain Market Share. But, with the rate of Market
Graphite India 15.3 206.7 67.1
Share addition expected to slow down, we expect GIL to retain a larger part of this
cost advantage and thereby improve its Margins over historical average levels.

Key Financials (Consolidated)
Y/E March (Rs cr) FY2009 FY2010E FY2011E FY2012E
Net Sales 1,498 1,418 1,603 1,913
% chg 12.6 (5.4) 13.0 19.3
Profit
Net Profit 237 242 237 275
% chg 66.4 2.3 (2.3) 16.1
EBITDA Margin (%) 24.4 29.0 24.4 24.2
FDEPS (Rs) 11.6 11.0 12.1 14.0
P/E (x) 8.3 8.7 7.9 6.8
P/BV (x) 1.5 1.3 1.2 1.1
RoE (%) 25.3 20.1 16.5 16.5
RoACE (%) 20.4 21.7 20.1 20.9
Jai Sharda
EV/Sales (x) 1.1 1.2 1.3 1.0
+91 22 4040 3800 Ext: 305
EV/EBITDA (x) 4.7 4.1 5.2 4.2 Email: jai.sharda@angeltrade.com
Source: Company, Angel Research

Please refer to important disclosures at the end of this report

Graphite India | Initiating Coverage

Investment Arguments
Steel Demand to Drive Graphite Electrodes Industry

Volume
Sharp Volume declines due to the Graphite electrodes are a main input for steel manufactured via the EAF route. However,
global financial crisis... in the current decade, steel production through the EAF route, as a percentage of
total steel manufactured, has declined from 33.9% in CY2000 to 30.7% in CY2008
due to the substantial Blast Furnace capacity addition, mainly in China. Hence, the
contribution of steel manufactured through EAF in China fell from 15.9% in CY2000
to a mere 9.1% in CY2008. Also, hit by the global recession, the steel manufacturers
cut production and were inclined to reduce their inventory levels, which in turn adversely
impacted the Graphite Electrodes Industry. It is estimated that EAF steel production
fell more than the blast furnace steel production, with the EAF method contributing
only around 27.9% to the total steel production in CY2009, compared to around
30.7% in CY2008. The main reason for this phenomenon is that steel producers shut
down EAF capacity first in case of any demand downturn and only if the downturn is
severe, shut down Blast Furnace capacity, as Blast Furnace capacity is not suited to
rapid stoppage and re-starts. Graphite Electrode production across the world fell by
another 15.0% yoy in CY2009 owing to de-stocking of inventory by EAF steel
manufacturers. Therefore, Graphite Electrode production fell by nearly 33.0% yoy in
CY2009. Consequently, Global leaders like SGL Carbon and GrafTech recorded
overall Volume declines of nearly 33.0% yoy and 55.0% yoy respectively in CY2009.
However, GIL fared relatively better in the corresponding period of FY2010, registering
a Volume drop of about 25.0% yoy.
Exhibit 1: Percentage of Global Steel produced via EAF route
70

60

50

40
(%)

30

20

10

0
CY00

CY01

CY02

CY03

CY04

CY05

CY06

CY07

CY08

Japan South Korea EU US China World
Source: World Steel Association

... are now expected to reverse Going ahead, we expect steel production volumes to strengthen and register a CAGR
of 5.3% over CY2009-12E. Besides, the proportion of steel produced through the EAF
route is expected to return to levels of 30.7% in CY2010E, as the plants that were shut
down owing to recession become operational again. The steel manufacturers are
expected to build electrode inventory levels once industry growth visibility becomes
clearer. Further, as more steel gets pumped into the Chinese economy, more EAF
capacities are expected to get added to recycle the steel. This trend has been
observed in almost all the developed economies in the past. Even in China,
production via the EAF route has more than doubled, increasing from 20.2MT in
CY2000 to 45.5MT in CY2008. Therefore, we expect steel production via the EAF
route to increase to 33.0% of the total steel production by CY2020E. Thus, graphite
electrode production, across the globe, is also set to revive post the slack in CY2009.

April 28, 2010 2


Exhibit 2: Steel Sales to rebound from CY2009 lows
Particulars CY06 CY07 CY08 CY09 CY10E CY11E CY12E
Total Steel Production (mn mt) 1,247.3 1,346.2 1,329.1 1,219.7 1,280.7 1,351.1 1,425.5
% Inc 9.0 7.9 (1.3) (8.2) 5.0 5.5 5.5
% of Steel produced via EAF 31.6 30.8 30.7 27.9 30.7 30.9 31.1
Steel produced via EAF route (mn mt) 395.4 416.6 407.0 340.0 393.2 417.4 443.1
% Inc 8.3 5.4 (2.3) (16.5) 15.6 6.2 6.2
Specific Consumption 2.2 2.1 2.0 1.9 1.8 1.8 1.7
of Graphite Electrodes (kg/MT)
Demand decline due to inventory 0.0 0.0 0.0 15.0 0.0 0.0 0.0
De-Stocking (%)
Demand for Graphite Elec. (MT) 830,260 833,200 773,332 527,136 695,637 723,709 752,885
GIL Volumes (MT) 59,843 65,380 60,000 45,000 57,329 65,471 74,108
GIL Market Share (%) 7.2 7.8 7.8 8.5 8.2 9.0 9.8
Source: World Steel Association, Company, Industry, Angel Research

Graphite Electrodes consumed to produce one MT of steel through the EAF route,
also known as the Specific Consumption, is currently slightly over 1.8kg. The
estimated Graphite Electrodes market for EAF steel production in CY2010 is
estimated to be about US$3.5 bn.

Exhibit 3: Graphite Electrodes Estimated Market Size in CY2010
Graphite Electrode Consum. for 1 MT of Steel Prod. via EAF route 1.8 kg
Steel Produced via EAF route in CY2010 (est.) 393.2 mn MT
Graphite Electrode Consum. for EAF Steel Prod. in CY2010 695,600 MT
Assuming Graphite Electrode Cost per MT US$ 5,000
Graphite Electrode Market Size in CY2010 US$ 3.5 bn
Source: Industry, Angel Research

Labour Cost Advantage
GIL - Edge over peers on low labour costs

GIL’s Margins are relatively shielded
GIL’s Labour is an important cost component in the Graphite Electrodes industry and GIL is
than its global peers as it enjoys cost placed advantageously in this regard compared to its global peers as its capacity is
advantages arising from low labour mostly located in India. The other major global players have capacities in location
costs where labour costs are significantly higher. SGL Carbon SE, the largest player in the
world, has 39 plants, 20 of which are located in Europe, 12 in North America and 7
in Asia. GrafTech, the second biggest player, has five plant locations, one each in
France, Spain, South Africa, Mexico and Brazil. Showa Denko and Tokai Carbon, the
next two biggest players, have a majority of their employees based in Japan. As an
indication of GIL’s labour cost advantage, in FY2009, Employee cost accounted for
9% of GIL’s Total Sales, while it was a high 23% (in CY2008) for SGL Carbon. As a
result of this cost advantage, GIL is strongly placed to defend its Margins.

April 28, 2010 3


Exhibit 4: GIL - Strong Labour Cost advantage to protect Margins
35.0

30.0

Labour cost/ Sales (%)
25.0

20.0

15.0

10.0

5.0

-

CY04/FY05

CY05/FY06

CY06/FY07

CY07/FY08

CY08/FY09
SGL GIL

Source: Company

In the past, GIL garnered market share on the back of capacity expansions. GIL also
passed on some of the cost advantages that it availed from the low cost of production
by reducing the price of its products to maintain high capacity utilisation levels. GIL's
average graphite electrode realisations were at around Rs2.0lakh in FY2009
compared to realisations of global leaders, which stood at around Rs2.5lakh for the
corresponding calender year (CY2008). This is also reflected in GIL's Margins, which
are comparable to those of SGL, despite its strong labour cost advantage.

Going ahead, with GIL having Having enhanced capacity at a CAGR of 12.0% over FY2002-09, the Company’s
garnered sizable market share and plans over FY2009-13E are relatively conservative, with Volumes recovery post-crisis
capacity growth rate likely to taper still not complete. Accordingly, it is expected to register slower CAGR in capacity
CAGR FY2009-13E,
down to 3.4% CAGR over FY2009-13E, addition of 3.4% over FY2009-13E. We expect that due to the lower rate of capacity
we expect the company to addition, GIL will not require to undercut its global peers and the price gap between
retain a higher proportion of the GIL's products and the top global players will reduce. The company's market share
labour cost benefits resulting in gains are also expected to decelerate to touch 9.0% in FY2012E compared to the
overall Margin expansion robust growth witnessed earlier from around 4.2% in FY2005 to 7.8% in FY2009. On
account of having sizable market share and lower rate of capacity addition, we
expect GIL to retain a higher proportion of the labour cost benefits.

Overall on the back of these factors, we expect GIL to register an improvement in
OPM to 24.4% in FY2011E and 24.2% in FY2012E compared to historical levels of
20.3% (previous five years’ average).

Exhibit 5: Lower rate of Capacity expansion and stable Market share
90,000 10.0
80,000 9.0
70,000 8.0
(MT/ Year)

60,000 7.0
6.0
50,000
(%)

5.0
40,000
4.0
30,000 3.0
20,000 2.0
10,000 1.0
- -
FY05

FY06

FY07

FY08

FY09

FY10E

FY11E

FY12E

Capacity (LHS) Market Share (RHS)
Source: Company, World Steel Association, Industry, Angel Research

April 28, 2010 4


Strong Entry Barriers
The global Graphite Electrodes industry is characterised by high level of consolidation,
with the Top-6 players accounting for over 70% of the total installed capacity in the
world. The balance capacity is owned by a motley of small players.

Exhibit 6: Global Graphite Electrode Manufacturing Capacity
300

(’000 Tonne/year) 250
200

150
100

50
0

HEG Ltd
Graphite India
Showa Denko
SGL Group

Tokai Carbon
GrafTech

Source: Company

Technology and Knowledge Barriers
Only the top global players own the The highly consolidated nature of the industry is owing to the barriers for the new
high-quality
technology to manufacture high-quality entrants. For instance, only the top global players have the technology to manufacture
ultra high power (UHP) graphite high-quality ultra high power (UHP) graphite electrodes. Few players, especially in
electrodes China, have copied the technology and started production of UHP electrodes. However,
they have not been able to match the quality of the top manufacturers, as they lack
the knowledge of customisation in the electrodes required for each furnace. Moreover,
the EAFs require specific properties in electrodes, which the existing players already
possess owing to their years of experience in dealing with the steel manufacturers.
The new players lack this knowledge, which is why their product quality is not able to
match those of the established players.

Relationship oriented Industry

Graphite electrodes cost only 2-3% of The industry is marked by a relationship and referral based model. A new entrant has
the total price of manufactured steel to prove the quality of its products by supplying to a steel manufacturer and then get
and the steel players are generally not referral and word-of-mouth publicity for the products from the manufacturer. The
ready to risk the quality of their entire process often takes several years, as the steel manufacturers are not inclined to
high-value products for savings on this try out a new supplier. This is because graphite electrodes cost only 2-3% of the total
relatively small cost item price of manufactured steel and the steel players are generally not ready to risk the
quality of their high-value products for savings on this relatively small cost item.

Access to the key Raw Material, Needle Coke

On the suppliers' side also, there is an entry barrier owing to the scarcity of Needle
Coke, a key raw material required in the manufacture of high grade UHP electrodes.
It may be noted here that Needle Coke across the world is supplied by a select group
of suppliers. All the existing players have been dealing with the same set of suppliers
for years on end. These suppliers also have a strong understanding with the electrode
manufacturers. Hence, for any new player breaking into this network, to ensure a
secure supply of Needle Coke, proves to be a barrier.

April 28, 2010 5


High cost of Greenfield Capacity

As per industry estimates, new entrants Another barrier for the new as well as some of the existing players is the high cost of
require to invest Rs500cr to set up a setting up a green-field graphite electrodes manufacturing facility. As per industry
year,
greenfield capacity of 10,000MT/ year, estimates, around Rs500cr is required to set up a green-field plant with a capacity of
while established players like GIL need 10,000MT/year. Brownfield expansions are however relatively much cheaper. In case
to incur capex of only Rs200cr towards of GIL, it expects to incur total Capex of over Rs200cr for the 10,000MT/year Brownfield
brownfield expansion expansion at its Durgapur plant. Even on lower fixed asset cost, GIL has been recording
average RoE of around 20.0% in the last four years. In fact, returns for the new
players setting up green-field capacity are even lower, making the industry unattractive
for these players. In fact, we expect GIL to be one of the few players to expand
manufacturing capacity in the near term.

Moreover, GIL’s existing facilities have been built over the years. Hence, its Gross
Block is relatively small. As mentioned earlier, new players would be able to develop
a capacity of only 20,000MT/year at a cost of Rs1,000cr, whereas GIL's entire Gross
Block size for 78,000MT/year of capacity is slightly under Rs1,000cr. This gives GIL
significant fixed cost advantages over the new entrants.

April 28, 2010 6


Financial Overview
Consolidated Top-line to rebound on higher Volumes post FY2012E
Volumes
We expect Volumes to increase to GIL has undertaken capacity expansion at its Durgapur facility from around
nearly 72,000MT by FY2013E , 34,000MT/year to 44,500MT/year to be completed in FY2012E. This expansion is
CAGR
implying a CA GR of 18.1% over expected to help the company maintain its growth momentum going forward. However,
FY2010-13E full benefits of the capacity expansion are expected to kick in post-FY2012E. The
company can further increase capacity of the Durgapur plant to around
54,000MT/year once utilisation of the expanded capacity reaches optimum levels.
Thereafter, the company could also look at enhancing capacity of its Nasik and
Bangalore plants as well. Overall, we expect Volumes to increase to nearly 72,000MT
by FY2013E, implying a CAGR of 18.1% over FY2010-13E. Over FY2010E-12E, we
expect Volumes to increase at a CAGR of 20.6% to over 65,000MT.

Exhibit 7: Volumes to increase on Capacity expansion
Particulars FY07 FY08 FY09 FY10E FY11E FY12E FY13E
Capacity (MT/year) 73,000 73,000 73,000 73,000 73,000 83,500 83,500
Volumes (MT) 59,843 65,380 60,000 45,000 57,329 65,471 74,108
Capacity Utilisation (%) 82.0 89.6 82.2 61.6 78.5 78.4 88.8
Source: Company, Angel Research;

CAGR
GIL to post decent Revenue CAGR of GIL posted a surge in Top-line CAGR of 27.8% during FY2005-09, primarily driven
16.1% over FY2010E -12E
FY2010E-12E by the addition of the German facility, higher Sales from the Indian plants and strong
growth recorded by the global industry. However, GIL's Top-line is expected to decline
by 5.4% yoy in FY2010E due to the reduction in steel production and de-stocking of
inventories by the steel manufacturers. In FY2011E too, growth is expected to remain
sluggish due to a 10.0% yoy decline in Realisations. However, in FY2012E, the company
is expected to record a bounce-back following an improvement in Volumes and an
assumed nominal 6.0% yoy increase in Realisations. The Realisations have been
assumed based on the trend which has been observed over FY2002-08, wherein they
recorded a 6.0% CAGR. Thus, we expect GIL to post decent Revenue CAGR of 16.1%
over FY2010E-12E.

Exhibit 8: Sales Growth to rebound from FY2012E onwards
2,500 50

2,000 40

30
1,500
(Rs cr)

(%)

20
1,000
10
500 0

0 (10)
FY05

FY06

FY07

FY08

FY09

FY10E

FY11E

FY12E

Sales (LHS) Topline Growth (RHS)

April 28, 2010 7


OPMs to remain robust
Post the spurt in Margins in FY2010E,
FY2010E, GIL has been registering consistent expansion in OPM increasing from 18.0% in
GIL’s
we expect GIL’s OPMs to stabilise and FY2005 to 24.4% in FY2009 primarily due to the surge in graphite electrode prices
come in at 24.2% in FY2012E and volumes. For FY2010E, we estimate OPM to further expand to 29.0% mainly due
to higher electrode prices and lower manufacturing and raw material costs. Notably,
at the beginning of FY2010, needle coke players had set their prices at high levels
and electrode manufacturers had passed on a part of the same. In the interim, the
prices of other raw materials and manufacturing costs have fallen, leading to an
improvement in GIL’s Margins. SGL and GrafTech had priced their products higher in
CY2009 based on inventories purchased at higher costs. GIL also enjoyed the
benefits of these higher prices. However, having relatively lower cost inventories, GIL
is expected to post an increase in its Margins in FY2010E. Since the increase in
Margins in FY2010E is due to the one-off gains in inventory, these Margins are not
sustainable. Nonetheless, in general, OPMs are expected to expand compared to the
historical levels, owing to the lower need to undercut the global peers on the company’s
part. Post the spurt in Margins in FY2010E, we expect GIL’s OPMs to stabilise and
come in at 24.4% in FY2011E and 24.2% in FY2012E.

Exhibit 9: Strong EBITDA, OPM
500 35
450
30
400
350 25
(Rs cr)

300 20

(%)
250
200 15
150 10
100
5
50
0 0
FY10E

FY11E

FY12E
FY05

FY06

FY07

FY08

FY09

EBITDA (LHS) OPM (RHS)

Power unit to spur Margins FY2013E onwards
Power
On completion of the Power unit, we Currently, the company is in the process of setting up a 50MW power plant at its
EBITDA
estimate EBITDA to increase by around Durgapur facility at an estimated cost of Rs214cr. Post completion of this unit by the
Rs58.6cr or 2.6% of Sales in FY2013E end of FY2012E, the company is expected to reduce its Operating costs from FY2013E
on 15% Return on Investment (RoI) onwards. Thus, we estimate EBITDA to increase by around Rs58.6cr or 2.6% of Sales
in FY2013E on 15% Return on Investment (RoI).

Exhibit 10: Power Cost Savings (Rs cr)
Investment (Capex) 214.0
RoI (%) 15.0
Contribution to PAT 32.1
Tax Rate (%) 33.0
Contribution to PBT 47.9
Interest -
Depreciation Rate (%) 5.0
Depreciation 10.7
Total Power Cost Savings 58.6

April 28, 2010 8


Capex Plans

GIL has drawn up two major capex plans for both its Durgapur facilities. These
expansions are expected to be completed by FY2012E. The company plans to
augment its graphite electrodes capacity by 10,500 MT/year as well as install a
50MW power plant. The company proposes to incur capex to the tune of
Rs200-220cr for each of these projects. Regular maintenance capex of around Rs20cr
would also be incurred every year. GIL’s capex requirements would be met through
internal accruals.

Exhibit 11: Capex to remain High
250.0

200.0
(Rs cr)

150.0

100.0

50.0

-
FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10E

FY11E

FY12E

FCCB conversion
GIL’s
FCCB conversion would result in GIL’s The company had FCCBs worth Rs 156.9cr on its books in FY2009. Around Rs3.0cr
Debt/Equity ratio declining from 0.47x of these FCCBs got converted into Equity in FY2010 and the balance is expected to
in FY2009 to a mere 0.15x in FY2012E get converted into Common Stock in FY2011E at Rs55.3/share. This will increase the
company's equity base from Rs34.2cr in FY2009 to an estimated Rs39.1cr in FY2011E,
a dilution of 14.3%. Consequently, GIL’s Debt/Equity ratio would decrease from 0.47x
in FY2009 to a mere 0.15x in FY2012E.

Return Ratios

We believe that Ratios of FY2011E and We expect GIL's Return Ratios to remain relatively depressed in FY2011E and FY2012E,
FY2012E are incorrect indicators of with RoE for these years estimated at 16.5% each, primarily due to the FCCB
GIL's sustainable Returns, as they would conversion and the company's capex over the period. Post the FCCB
increase once the new electrode and conversion, the company would get under-leveraged and have a Debt-Equity ratio of
power capacities get fully operational 0.15x in FY2012E. The augmented capacity is expected to achieve full scale of
post FY2012E operation after FY2012E, whereas it gets capitalized in FY2012E itself. Therefore, we
believe that these Return Ratios (FY2011E and FY2012E) are incorrect indicators of
the company's sustainable Returns, which would increase once the new electrode and
power capacities get fully operational post FY2012E.

April 28, 2010 9


Key Concerns
Limited supply of needle coke

Needle coke required to manufacture the high grade UHP graphite electrodes, is
manufactured during the sweet crude oil refining process. Needle coke supplies the
world over is limited as sweet crude oil is produced by few players and is in
diminishing supply across the world. Consequently, the availability of needle coke
may constrain GIL's future growth prospects. The needle coke
manufacturers could also steeply price their products. However, this risk is mitigated
by GIL's ability to pass on a part of the same to its customers.

Greater-than-expected reduction in Graphite prices

The global graphite electrode manufacturers are currently operating at low utilisation
rates of around 50%, which is set to increase to around 60% in CY2010E. However,
there exists a threat that these players may slash prices in their bid to improve utilisation
rates. Graphite electrode prices are expected to decline by 5-10% yoy in FY2011E
mainly due the decline in needle coke prices in that year. If, however, the global
players reduce the prices more than this in a bid to improve their utilisation rates, it
might hurt GIL's realisations too. However, this threat is limited as the global players
have higher cost structures.

Exposed to currency fluctuation

GIL has a natural hedge against currency movement to a large extent, as its export
income is offset by the import of needle coke. For instance, the total foreign exchange
earnings for GIL in FY2009 were Rs601.4cr, compared to the foreign currency outgo
of Rs321.2cr in the same period. As for the remaining exposure, the company uses
hedging tools sparingly. As such, it is mostly exposed to currency movements.

Reducing specific consumption of graphite electrodes

The amount of electrodes consumed in the preparation of one tonne of steel, known
as specific consumption, has been consistently declining in recent years due to
technological advancements in both steel-making and graphite electrodes. This
decline is expected to continue going ahead as well. This implies that the Graphite
Electrodes Industry will grow at a lesser pace structurally, compared to EAF steel
industry production through the EAF method. However, with technological progress
becoming more expensive and tougher to achieve, this decline in specific
consumption is expected to be gradual. Consequently, we expect specific
consumption to decline from around 1.90 in CY2008 to 1.70 in CY2012E and 1.67
in CY2013E.

Exhibit 12: Specific Consumption of Graphite Electrodes to Decline at Lower Pace
Year CY05 CY06 CY07 CY08 CY09(E) CY10(E) CY11(E) CY12(E) CY13(E)
Specific Consum. 2.2 2.1 2.0 1.9 1.8 1.8 1.7 1.7 1.7
(kg/MT of Steel)
% Increase (4.3) (4.5) (4.8) (5.0) (4.0) (3.0) (2.0) (2.0) (2.0)

April 28, 2010 10


Outlook and Valuation
Global steel production after posting a CAGR of 8.3% over CY2002-07 took a hit in
CY2008 and CY2009 due to the global financial crisis and declined by 1.3% yoy and
8.2% yoy during these years respectively. The steel companies that manufactured
steel via the EAF method reduced their inventory due to the demand uncertainty.
However, going forward, steel production via EAF route is expected to revert back on
growth trajectory and de-stocking of inventory is also expected to reverse. Amdist this
scenario, GIL, the fifth largest producer of graphite electrodes, is well poised to exploit
the growth opportunity given the strategic advantages that it possesses vis-à-vis its
peers. The capacity expansion at the Durgapur plant is expected to provide the requisite
trigger for future growth.

We expect GIL to register a CAGR of 16.1% in Top-line Top-line over FY2010E-12E,
while Bottom-line is expected to increase at a CAGR of 6.5% over the period. The
relatively low Bottom-line growth is expected primarily due to the difference in the
OPM for the two years.

On the bourses, the stock has historically traded in the range of 0.5x to 1.5x its one
year forward Book Value and a band of 4x to 8x one-year forward EPS. However, we
believe that the market has historically valued GIL's core earnings, rather than
accounting for one time benefits like tax advantages and other income. Adjusting for
these one-time impacts, the P/E range would be much higher for the stock. As such,
the P/BV is a more appropriate method of valuing the stock. The stock is currently
trading at 1.1x its FY2012E Book Value and 6.8x its FY2012E EPS. We have assigned
a Target Multiple of 1.3x to its one-year forward Book Value, based on the average
sustainable RoEs of 17.0% and a growth rate of 5.0%. We believe that the RoEs of the
company going forward would be higher than the past average and therefore, we
have assigned a the multiple on the higher side of the band. We Initiate Coverage
Target Price
on the stock, with a Buy recommendation and a Target Price of Rs117.

Exhibit 13: One-year Forward Rolling P/BV Band
140

120

100

80
(Rs)

60

40

20

0
Jul-02
Nov-02

Nov-03
Mar-02

Mar-03
Jul-03

Nov-04

Jul-05
Mar-04

Nov-05
Mar-05

Nov-09
Mar-09
Jul-04

Jul-06
Nov-06

Jul-09
Mar-06

Jul-08
Mar-07

Nov-08
Mar-08
Jul-07
Nov-07

Mar-10

Price 0.2x 0.5x 0.8x 1.1x 1.5x

Source: C-line, Angel Research

April 28, 2010 11


Exhibit 14: One-year Forward Rolling P/E Band
140

120

100

80

(Rs)
60

40

20

0

Nov-02
Mar-02
Jul-02

Jul-03
Mar-03

Nov-03

Jul-04

Jul-05

Jul-09
Mar-04

Nov-04
Mar-05

Nov-05
Mar-06

Mar-09

Nov-09
Jul-06
Nov-06

Mar-08
Jul-08
Mar-07

Nov-07

Nov-08
Jul-07

Mar-10
Price 2x 4x 6x 8x
Source: C-line, Angel Research

Exhibit 15: Comparative Valuation
Company Equity M Cap EPS (Rs) P/E (x) P/BV (x)
P/BV Angel RoIC
(Rs cr) (Rs cr) FY10E FY11E FY12E FY10E FY11E FY12E FY10E FY11E FY12E FY10E FY11E FY12E
Graphite India Ltd 34.3 1,670 11.1 12.1 14.0 8.7 8.0 6.8 1.3 1.2 1.1 19.1 16.6 13.9
HEG Ltd 42.8 1,555 41.1 37.6 54.1 7.4 8.2 5.6 1.8 1.5 1.3 18.9 16.9 16.5
Source: Company, Angel Research; Note: HEG P/E and P/BV data adjusted for investment in Bhilwara Energy Ltd.

Business Overview
Graphite Electrode is the raw material required in the EAF method of producing steel.
In the EAF process, an electric current is passed through the scrap metal charge and
the heat generated from the electric arc between the electrodes and the scrap is used
to melt the scrap. These electrodes are made of graphite. In this process, graphite
electrodes are consumed owing to high heat generated. A single two-tonne graphite
electrode lasts for about 8-9 hours during the process.

GIL is one of the leading players in this industry and supplies graphite electrodes to
steel manufacturers across the world. It is an offspring of the venture between its
current promoters, the Bangur family and Great Lakes Carbon Crop (USA), incorpo-
rated in 1962. The company has since grown to be the fifth largest player in the world
in the electrodes business.

April 28, 2010 12


Exhibit 16: Key Milestones

2009: Powmex Steel, an undertaking of GKW Limited, was 2009
merged with the Company
2006 2006 Expanded Durgapur plant capacity from 14K MT to
:
34K MT p.a., taking group capacity to 78K MT p.a.
2004: Acquired 18K MT electrode manufacturing facility in
2004
Nurnberg, Germany, from Conradty

2002 2002 Second 1.5MW hydel power plant commissioned in
:
Karnataka
2001: Graphite India formed from merger of two leading 2001
graphite electrode players in India

2000 2000 : Installed a 7.5MW multi- fuel power plant at Nasik

1998: Installed 24MW power capacity in Karnataka 1998

1994: Backward integration through acquisition of two CPC
1994
manufacturing units in Barauni

1974: Promoted Carbon Corp Ltd with horizontal transfer of
1974
technology to manufacture graphite electrodes in Nasik (Mah)

1971 1971 : Fully integrated plant established in Bangalore

1967: Durgapur plant commenced production 1967

1962: Predecessor company formed by Bangur family and Great
1962 Lakes Carbon Corp (USA)

Source: Company

Business Segments

The company operates across four Divisions: Graphite and Carbon, Steel, Power and
Others. The Graphite and Carbon Division remains the most dominant segment,
with 93.3% of the company Sales coming from this segment. Going forward, we
expect the segment to continue to dominate Sales and contribute around 90.0% to
the company's Top-line in FY2012E.

Exhibit 17: Segment-wise Revenue Break Up

FY09 FY12E

1% 6% 7%
3%

93% 90%

Graphite & Carbon Steel Power & Others Graphite & Carbon Steel Power & Others


April 28, 2010 13


Graphite and Carbon

The primary product of this Division is graphite electrodes. The company has four
plants to manufacture graphite electrodes, one of which is in Germany and the other
three are situated across India. The German facility with a capacity of 18MT was
acquired in 2004 from Conradty. GIL is currently in the process of setting up a
Brown-field capacity at its Durgapur plant. The company is one of the few players in
the world with access to technology to manufacture Ultra High Power (UHP) electrodes.
Besides graphite electrodes, this Division also produces calcined petroleum coke
(CPC), electrode and tamping paste under the Coke Sub-Division located in Barauni.

Power

The company has a 25.5MW capacity hydel power plant at Karnataka. It also has a
7.5MW multi-fuel power plant at Nasik. These plants primarily meet the company's
captive power requirements. Excess production is sold to third parties. Going ahead,
the company's total power generating capacity is set to increase to 83MW in FY2012E,
with the addition of the 50MW thermal power plant to be set up at the Durgapur unit.

Steel

GIL acquired the high-speed steel manufacturer, Powmex Steel, in FY2009 primarily
to avail the tax benefits attached to the steelmaker. This Division does not constitute
the company's core business, and going ahead the company may look at hiving it off.

Other Divisions

Others Divisions of the company comprise the Impervious Graphite Equipment (IGE)
and Glass Reinforced Pipes (GRP) Divisions. IGE manufactures heat exchangers,
ejectors, pumps and turnkey plants, which find application in industries involved in
corrosive chemicals such as pharmaceuticals, agro-chemical, chlor-alkali and
fertilisers. GRP pipes are used in the transportation of water, sewage, effluents, etc.

April 28, 2010 14


Profit & Loss Statement (Consolidated) Rs crore
Y/E March FY2007 FY2008 FY2009 FY2010E FY2011E FY2012E
Gross sales 1,171 1,388 1,558 1,481 1,686 2,010

Less: Excise duty 53.2 57.1 59.5 62.7 83.0 97.5

Net Sales 1,118 1,331 1,498 1,418 1,603 1,913

Other operating income - - - - - -

Total operating income 1,118 1,331 1,498 1,418 1,603 1,913
% chg - 19.1 12.6 (5.4) 13.0 19.3

Total Expenditure 893 1,054 1,133 1,008 1,212 1,451

Net Raw Materials 358 468 487 425 513 612

Other Mfg costs 301 321 381 315 377 451

Personnel 117 130 135 135 157 191

Other 117 134 130 132 165 196

EBITDA
EBITDA 225 278 366 411 391 462
% chg - 23.5 31.8 12.2 (4.8) 18.3

(% of Net Sales) 20.1 20.9 24.4 29.0 24.4 24.2

Depreciation& Amortisation 38 41 44 48 49 60

EBIT 187 237 322 362 342 402
% chg - 26.4 36.0 12.6 (5.7) 17.7

(% of Net Sales) 16.7 17.8 21.5 25.6 21.3 21.0

Interest & other Charges 37 43 35 26 14 18

Other Income 131 29 25 25 25 25

(% of PBT) 46.7 13.2 8.1 7.0 7.2 6.2

Share in profit of Associates - - - - - -

Recurring PBT 281 223 312 362 353 410
% chg - (20.7) 39.8 15.9 (2.3) 16.1

Extraordinary Expense/(Inc.) - - 57 - - -

PBT (reported) 281 223 255 362 353 410

Tax 59 81 18 119 117 135

(% of PBT) 20.9 36.2 7.1 33.0 33.0 33.0

PAT (reported) 223 142 237 242 237 275
Add: Share in profit of asso. - - - - - -

Less: Minority interest (MI) - - - - - -

Prior period items 75 (0) (1) - - -

PAT after MI (reported) 223 142 237 242 237 275
ADJ. PAT
ADJ. PA 147 143 238 242 237 275

% chg - (3.3) 67.3 1.6 (2.3) 16.1

(% of Net Sales) 13.2 10.7 15.9 17.1 14.8 14.4

Basic EPS (Rs) 15.1 9.6 15.3 14.1 12.1 14.0

Fully Diluted EPS (Rs) 12.5 8.0 11.6 11.0 12.1 14.0

% chg - (36.2) 45.4 (4.7) (9.7) 16.1

April 28, 2010 15


Balance Sheet (Consolidated) Rs crore
SOURCES OF FUNDS

Equity Share Capital 29 30 34 34 39 39

Preference Capital - - - - - -

Reserves& Surplus 614 725 1,085 1,261 1,535 1,718

Funds
Shareholders Funds 643 755 1,119 1,296 1,574 1,757

Minority Interest

Total Loans 706 619 528 276 122 272

Deferred Tax Liability (Net) 64 70 62 63 63 63

Total Liabilities 1,413 1,444 1,709 1,634 1,758 2,091

APPLICATION OF FUNDS
APPLICATION

Gross Block 815 834 995 1,015 1,035 1,470

Less: Acc. Depreciation 262 303 435 484 533 593

Net Block 553 531 559 531 502 877

Capital Work-in-Progress 8 9 14 122 259 15

Goodwill - - - - - -

Investments 111 106 101 101 101 101

Current Assets 993 1,133 1,336 1,198 1,273 1,529

Cash 92 66 177 137 19 35

Loans & Advances 118 108 132 125 141 168

Inventories 439 534 695 567 641 765

Debtors 344 412 318 355 458 547

Other - 13 14 14 14 14

Current liabilities 252 335 301 317 377 431

Net Current Assets 741 798 1,035 880 897 1,099

Mis. Exp. not written off - - - - - -

Total Assets 1,413 1,444 1,709 1,634 1,758 2,091

April 28, 2010 16


Cash Flow Statement (Consolidated) Rs crore

Profit before tax 281 223 254 362 353 410

Depreciation 38 41 44 48 49 60

(Inc.)/ Dec. in Working Capital (166) (92) (103) 108 (118) (159)

Less: Other income 131 29 25 25 25 25

Direct taxes paid 59 81 18 119 117 135

Cash Flow from Operations (38) 62 151 373 142 151

(Inc.)/ Dec. in Fixed Assets (76) (21) (165) (128) (157) (191)

(Inc.)/ Dec. in Investments (98) 5 5 - - -

(Inc.)/ Dec. in loans and adv. (29) 10 (24) 7 (16) (27)

Other income 131 29 25 25 25 25

Cash Flow from Investing (72) 23 (158) (95) (148) (193)

Issue of Equity - 23 4 3 133 -

Inc./(Dec.) in loans 89 (86) (91) (253) (154) 150

Dividend Paid (Incl. Tax) 51 53 60 68 92 92

Others 11 6 265 1 - -

Financing
Cash Flow from Financing 49 (111) 118 (318) (113) 58

Inc./(Dec.) in Cash (60) (25) 111 (40) (118) 16

Opening Cash balances 152 92 66 177 137 19

Closing Cash balances 92 66 177 137 19 35

April 28, 2010 17


Key Ratios
Valuation Ratio (x)
P/E (on FDEPS) 7.7 12.1 8.3 8.7 7.9 6.8
P/E (on basic, reported EPS) 6.4 10.0 6.3 6.8 7.9 6.8
P/CEPS 5.4 7.9 5.9 5.7 6.6 5.6
P/BV 2.2 1.9 1.5 1.3 1.2 1.1
Dividend yield (%) 3.1 3.1 3.1 3.5 4.2 4.2
Market cap. / Sales 1.3 1.1 1.1 1.2 1.2 1.0
EV/Sales 1.7 1.3 1.1 1.2 1.3 1.0
EV/EBITDA 8.3 6.1 4.6 4.0 5.2 4.1
EV / Total Assets 1.3 1.2 1.0 1.0 1.1 0.9
Per Share Data (Rs)
EPS (Basic) 15.1 9.6 15.3 14.1 12.1 14.0
EPS (fully diluted) 12.5 8.0 11.6 11.0 12.1 14.0
Cash EPS 17.7 12.1 16.4 16.9 14.6 17.1
DPS 3.0 3.0 3.0 3.4 4.0 4.0
Book Value 36.1 42.2 55.0 55.9 80.5 89.8
ROE Decomposition (%)
EBIT margin 16.7 17.8 21.5 25.6 21.3 21.0
Tax retention ratio 79.1 63.8 92.8 67.0 67.0 67.0
RoCE (Post Tax) 12.2 11.9 20.9 17.4 14.0 13.8
Cost of Debt (Post Tax) 4.4 4.1 5.7 4.4 4.7 6.0
Leverage (x) 0.7 0.6 0.3 0.1 0.0 0.0
Operating RoE 18.0 16.7 25.6 18.8 14.1 14.1
Returns (%)
RoCE (Pre-tax) 14.7 16.6 20.4 21.7 20.1 20.9
Angel RoIC * 12.3 12.0 21.1 19.1 16.6 13.9
RoE 26.3 20.4 25.3 20.1 16.5 16.5
Turnover ratios (x)
Asset Turnover (Gross Block) 1.5 1.6 1.6 1.4 1.6 1.5
Asset Turnover (Net Block) 2.1 2.5 2.7 2.6 3.1 2.8
Operating Income / Invested Capital 0.9 1.1 1.1 1.1 1.2 1.0
Inventory / Sales (days) 125 133 150 162 138 134
Receivables (days) 96 104 89 87 93 96
Payables (days) 79 82 77 78 70 69
Working capital cycle (ex-cash) (days) 180 189 194 206 184 185
Solvency ratios (x)
Gross debt to equity 1.1 0.8 0.5 0.2 0.1 0.2
Net debt to equity 0.8 0.6 0.2 0.0 0.0 0.1
Net debt to EBITDA 2.2 1.6 0.7 0.1 0.0 0.3
Interest Coverage (EBIT/ Int) 5.1 5.5 9.2 13.9 24.6 22.7
Note: *Operating EBIT/Avg (Cap employed - Cash- Marketable Investments - Goodwill - CWIP)

April 28, 2010 18

Graphite India

Disclaimer
This document is solely for the personal information of the recipient, and must not be singularly used as the basis of any investment
decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make
such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies
referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks
of such an investment.

Angel Securities Limited, its affiliates, directors, its proprietary trading and investment businesses may, from time to time, make investment
decisions that are inconsistent with or contradictory to the recommendations expressed herein. The views contained in this document are
those of the analyst, and the company may or may not subscribe to all the views expressed within.

Reports based on technical and derivative analysis center on studying charts of a stock's price movement, outstanding positions and trading
volume, as opposed to focusing on a company's fundamentals and, as such, may not match with a report on a company's fundamentals.

The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources
believed to be true, and is for general guidance only. Angel Securities Limited has not independently verified all the information contained
within this document. Accordingly, we cannot testify, nor make any representation or warranty, express or implied, to the accuracy, contents
or data contained within this document. While Angel Securities Limited endeavours to update on a reasonable basis the information
discussed in this material, there may be regulatory, compliance, or other reasons that prevent us from doing so.

This document is being supplied to you solely for your information, and its contents, information or data may not be reproduced, redistributed
or passed on, directly or indirectly.

Angel Securities Limited and its affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other
advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past.

Neither Angel Securities Limited, nor its directors, employees or affiliates shall be liable for any loss or damage that may arise from or in
connection with the use of this information.

Note: Please refer to the important `Stock Holding Disclosure' report on the Angel website (Research Section).

Disclosure of Interest Statement Graphite India
1. Analyst ownership of the stock No
2. Angel and its Group companies ownership of the stock No
3. Angel and its Group companies' Directors ownership of the stock No
4. Broking relationship with company covered No
Note: We have not considered any Exposure below Rs 1 lakh for Angel, its Group companies and Directors.

Ratings (Returns) : Buy (> 15%) Accumulate (5% to 15%) Neutral (-5 to 5%)
Reduce (-5% to 15%) Sell (< -15%)

Graphite india - Initiating Coverage 28.04.10

Graphite india - Initiating Coverage 28.04.10

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