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WhiteMonk HEG Equity Research Report
WhiteMonk HEG Equity Research Report
Report
HEG BUY
November 4, 2009
Dominant market share coupled with positive outlook of domestic steel sector makes it an attractive stock
Sector Electric Equipment EXECUTIVE SUMMARY
Category Large Cap Electrode and Graphite Sector: Each tonne of steel requires
Market Cap 11443.21M
Enterprise Value 18129.11M about 2.5 kg of graphite electrodes and thus demand for
FY09 Statistics graphite electrodes depends on steel production. The total size
Revenue 10990.9M
Net Profit 1070M
of domestic markets is estimated to be 26000-27000Tonnes per
Operating Margin 26% annum. HEG's market share within domestic market is around
Net Profit Margin 10% 42-43%. The World crude steel production for the month July
ROE 18%
ROA 6% 2009 stood at 103.9 million metric tons which is 11% lower
PE 10.88 when compared with corresponding period last year. The world
Sector PE 9.2 crude steel production despite being a lower when compared
P/BV 1.98
52- WEEK RANGE with July 2008 figures, was the highest monthly production
High INR284 figure during the calendar year 2009.Overall outlook for steel
Low INR94
Beta .53
sector is positive.
Return Analysis Company: HEG (BSE: 509631), is a large cap firms with market
One Month Return 4.49% cap of 11443.7MN, manufactures graphite electrodes, which are
Three Month Return 20.47%
One Year Return 76.46% used to produce steel from scrap by electric arc furnace (EAF)
technology. The Company exports over 80% of its production to
*1 US$ = INR46.52 more than 25 countries worldwide. The Company's operations
HEG PERFORMANC CHART (Price, Volume and
are organized into three business segments: graphite,
Volatility) steel/sponge and power. During the fiscal year ended March 31,
Volume Data 2009 (fiscal 2009), the production of graphite electrodes was
3 – Month Avg. Daily Volume 26087
50,226 million tons. The company has a number of respected
3-Month Avg. Daily Volume(in INR) 7130881
steel manufactures as clients such as ArcelorMittal, POSCO, US
3-Month Avg. Daily Volume .06% Steel, and Nucor
of total Market Cap Performance Analysis: Due to global slump and lower demand
for steel resulted in revenue growth of 8%, significantly lower
than FY08 revenue growth of 13%. Its margins has also declined
especially net profit margin from 15% in FY08 to 10% in FY09.
Valuation Summary: HEG is currently trading at INR 246.9, The
Fair value of the share is INR272, representing a minimum 10%
of upside potential.
2009
Sales Growth 8%
Operating Profit Margin 26%
Net Profit Margin 10%
ROE 18%
ROA 6%
Current Ratio 6.5
D/E 1.5
D/A 0.521
A/R Turnover 3.2
Days of sales outstanding 113.9
Inventory Turnover 1.7
Inventory Turnover days 213.1
Operating Cash Flow growth -24%
Capex as % of Sales 13%
What We liked:
Cash in Hand 6.4
HEG enjoys significant Market share in Electrode
Debt as % of (Expense + Capex) 91% and Graphite sector along with good client base.
Debt as % of Revenue 80% Good revenue growth in current economic
Interest Coverage 4.1 downturn
Management has decreased the expense by 1.8%
resulting in a significant PAT growth of 45%.
We have compared HEG‘s Return on Deployed Capital, Profitability, Asset Utilization and Financial Leverage with
industry data. We believe HEG has been giving superior returns on Equity and Deployed Capital so far. HEG’s
profitability in latest FY is superior then overall Industry average of profitability metrics. HEG is lagging behind on
Liquidity and Financial leverage front. HEG is more leveraged in comparison with overall Industry.
In 2009, EPS stood at INR24.04, 23% lower than 2008 EPS which was INR31.34. On an average EPS grew at 24%
per annum in last five year. Due to economic and current slowdown, the company experienced negative growth
in EPS. Following graph depicts EPS growth from 2004-2009.
EPS % Growth(2005-09)
100% 89%
79%
80%
60%
40%
20%
0%
2005 2006
-6% 2007 2008 2009
-20%
-20% -23%
-40%
Company has been paying dividend since 1991. In FY09, management has declared total INR27.43 dividend
which was lower 37% then FY08. Since 2001, Company has proven history of paying regular dividend with CAGR
of 16.54%. The Dividend details are as given below:
It is a liquid stock. Below is liquidity analysis of the stock for last two years (2007-09)
Total No. of
Open Price High Price Low Price Close Price Volume Trades
Minimum 94.5 97.8 94 94.5 987 13
Average 237.9 245.5 230.5 236.6 40393.9 732.2
Maximum 582.9 609 555.3 575.05 747646 8593
On average over 40 thousands stocks are trading which shows that there is a good market sellers as well as
buyers. The stock’s beta is .53 which makes it a highly stable stock.
VALUATION SUMMARY
We have valued HEG at share price of INR295.9, implying a minimum upside potential of 10% for its current
share price of Rs246 as of on 04 November 2009.The stock value has been arrived based on weighted average of
the price determined through Relative valuation and value investing methodology (Assuming 15% and 85%
weight respectively).
VALUATION DETAILS
1. Relative Valuation:
Following PE based approach; HEG is valued at INR 273.64, on the basis of 2010 EPS of INR67.4 and PE of
4.06.
%
Forecast Earnings 2009(e) 2010(e) change
Earnings per share (in INR) 48.5 67.4 39%
PE(x) 5.65 4.06 -28%
Dividend per share (in INR) 6.5 10 54%
Dividend Yield 2.37% 3.65%
Source*Reuters
Relative PE valuation
HEG 2010
EPS 4.06
2010PE(x) 67.4
Target Price 273.644
Based on EV/EBITDA approach, we have valued HEG at INR506.77, on the basis of 2010 EBITDA of
%
HEG 2009e 2010e Difference
Net Sales 13,283,000 17,411,000 31.1%
EBITDA 4,606,000 5,972,000 29.7%
EBIT 3,991,000 5,296,000 32.7%
Net Income 2,168,000 3,110,000 43.5%
*Source: Reuter
EV/EBITDA
All figures are in INRM ,except per share data
HEG 2010
EBITDA 5972.00
2010 EV/EBITDA(x) 3.04
EV 18154.88
Net Debt 8820.4
Market Value of Equity 11443.21
Shares 41
Target Price 506.77
3. EPV Valuation
EPV valuation is as given below, Our EPV calculation represent 11% potential upside from its current
share price.
Valuation
Summary
Current Share Price 247
EPV* 312.137
Intrinsic Value 279.30
Entry Price* 251.37
*Please see Exhibit 1 for definitions
4. Sensitivity Analysis
We did different scenario analysis for various WACC, CA and safety margins. Our selected scenario is in black.
Sensitivity
Table
WACC 9% 10.00% 11.00% 12.00% 12.97% 13.97% 14.97% 15.97%
EPV* 530.5 459.2 400.9 352.2 312.13 276.7 246.1 219.2
Safety Margin* 10% 10% 10% 10% 10% 10% 10% 10%
CA* 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75
Intrinsic Price 497.6 426.3 368.0 319.4 279.3 243.9 213.2 186.4
Entry Price* 447.9 383.7 331.2 287.5 251.4 219.5 191.9 167.8
*Please refer exhibits 1 for definitions
RISK ANALYSIS
Overall revenue projections, profitability and forecasted EPS would depend upon the sustained
demand from steel sector, Revenue growth may remain modest if economy recovery (growth in
GDP and steel sector growth) is lower than forecasted growth which will result in longer time to
realize upside potential in share price.
Historically, HEG has managed its debt well and has brought it down from 61% of total assets in
FY07 to 52% of total assets in FY09. At present Indian market is highly liquid but interest rate hikes
are expected in first quarter of FY10 by RBI (Reserve Bank Of India), which may result in added
financial burden to HEG. If we compare D/A ratio with industry average, Industry D/A ratio stands at
21.11% which is significantly lower than HEG’s D/A ratio of 52%.
RECOMMENDATION
EXHIBITS
EXHIBITS 1: ABBREVIATIONS
15%
10%
5% Heg
0% Linear (Heg)
-20% -10% 0% 10% 20%
-5%
-10%
-15%
EXPENDITURE :
Raw Materials 2686.3 2918.5 3054.2 1959.2 1350
Power & Fuel Cost 1750 1835.4 1769.6 1357.5 1121.7
Employee Cost 370.7 351.8 351.8 326.8 266.3
Other Manufacturing Expenses 940.4 658.3 662.8 419.6 381.8
Selling and Administration Expenses 1235.6 1048.6 883.4 600.6 588.2
Miscellaneous Expenses 1268.9 184.9 49.8 35.8 38.3
Less: Pre-operative Expenses Capitalized 0 0 0 0 0
0 0 0 0 0
Total Expenditure 8251.9 6997.5 6771.6 4699.5 3746.3
0 0 0 0 0
Operating Profit 2739 3060.4 2016.9 1207.6 842.3
Interest 669.6 537.6 540.3 281.9 103.6
Gross Profit 2069.4 2522.8 1476.6 925.7 738.7
Depreciation 455.5 450.9 476.4 396.2 243.2
Profit Before Tax 1613.9 2071.9 1000.2 529.5 495.5
Tax 525.5 702.9 118.5 51.1 61.2
Fringe Benefit tax 4.8 4.3 3.6 7.1 0
Deferred Tax 13.7 -98.9 139.7 82 22.8
Reported Net Profit 1069.9 1463.6 738.4 389.3 411.5
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