Peaking aluminium prices—is it an opportunity to enter or the time to get out of aluminium stocks?
LME aluminium chart shows peaking of aluminium prices. Particularly is it an opportunity to enter NALCO, which is available ex-dividend at about 68. Face value is 5. Book value is above 50. Debt free company. Big Capex plans over a decade. Good dividend yields. Probably capex will be largely through internal accruals, in view of good earnings.
Peaking aluminium prices—is it an opportunity to enter or the time to get out of aluminium stocks?
- Have the carbon stocks, specifically Graphite and HEG hit peak earnings or is there still room to go?
Dear @VP_Amit, Following are a few good reference materials:
- Research report that Jefferies came up with during Oct-17: https://ferroalloysmusings.files.wordpress.com/2017/10/steel_2017-10-11.pdf
- Blogs from the recent Global Graphite Electrode Conference 2018: http://events.steelmintgroup.com/blog/
- Recent research report by ICICIDirect: http://static-news.moneycontrol.com/static-mcnews/2018/02/IDirect_Graphite_SectorUpdate_Jan18.pdf)
These reports seem to provide a hint that, the shortage of the graphite electrodes and raw material needle coke is likely to stay there for some more time (possibly, a few more years). Key factors that impact the earnings of Graphite India and HEG have been prices of graphite electrodes and needle coke. During the calendar year 2017, the spot prices for the Graphite Electrodes in China increased from around USD 3,000 to around even USD 30,000 per MT. Similarly, the needle coke prices also have varied between USD 300 to USD 3,000.
Graphite India and HEG are still running on a few older contracts with low Graphite prices (say USD 3,000). They are expected to fully come out of these old contracts by end of Mar-18. As per the Q3’18 results of Graphite India, their average price realization for Graphite during Q3 seems to be around USD 6,600 per MT and needle coke around USD 1,270 per MT.
As the spot prices have recently increased to even USD 30,000 per MT for graphite and USD 3,000 for needle coke, I am not sure about the future contract prices. Hence, I have done some estimates on the FY19 EPS for Graphite India, keeping those two as the variables. I have assumed a fixed cost (employee cost, power cost etc.) of INR 1,200 crores per year and a capacity utilization of 90%. Please note that, the current TTM EPS of Graphite India is Rs. 26.71:
Disc: Invested in Graphite India
Thanks for the great explanation Madhavik. I am also considering taking a small position in Graphite/HEG, but after the phenomenal run last year for HEG and Graphite India, was wondering how much is already priced in. From your analysis and the reports you shared, seems like there is good headroom still.
Couple of questions:
a) why you invested in Graphite but not HEG? Goldman Sachs also seems to have a position in Graphite India and not HEG. Any specific reasons for the choosing Graphite India over HEG?
b) Going forward, what is the biggest risk you see to the Carbon story and under any circumstance do you foresee Graphite India/HEG falling badly? (say like falling 50%-70% from current levels)?
Hi @VP_amit, I have been an investor in both Graphite and HEG in the past and even rotated my allocations between these two at times. I believe that, if Graphite story continues to be great, both these companies should do extremely well. However, currently I am invested only in Graphite India for the following reasons:
Historically, Graphite India used to have healthier balance sheets and also come up with better and more consistent results. That way, I have always been more comfortable in investing in Graphite India.
HEG had given much higher returns over the past one year, as compared to graphite India. However, the above happened for some valid reasons. It had a lot of valuation gap with Graphite India which it had to catch up with. Sudden unexpected huge surge in the Graphite electrode prices helped it to almost completely pay off its high debt over the past year, thereby saving a lot on interest costs over the past couple of quarters, which increased its profitability significantly. HEG also had some advantages over Graphite India in terms of reduced operation costs (power, employees etc.), hence their operational margins have been higher over the past year.
However, I believe that, HEG has already caught up with Graphite India on the valuation front and possibly has become even more expensive now, if you take the balance sheet strength and past performance aspects of Graphite India also into consideration. Also, I think that, going forward, the operating margin difference between these two companies will get narrowed down a lot.
If you refer to the earnings estimate table which I had attached with my earlier post, I have assumed a fixed cost of USD 1,200 for Graphite india for FY19. For HEG also, the fixed cost may be more or less comparable (in proportion with its capacity), as it will no longer be able to save anything on interest costs from now onwards (already paid off the debt) and savings on other costs like power and employee would be very small compared to the overall revenue from now onwards. For instance, even if we assume the average Graphite electrode price to be as less as USD 8,000 per MT in FY19, the revenue would be INR 4,579. On that sort of revenue figure, the impact of an operational advantage of INR 50-100 crores due to power/employee costs will not be that significant.
The profitability of these two companies would really depend on what prices they could get into contracts with the customers for the electrodes and how much they could sell on the spot market and for what price. Also, the needle coke price would be the other variable, as I mentioned in my earlier post.
Hi @madhavikkutti , do you think the pollution control which is currently prevailing in China happen in India as well, if this happens than Graphite India and HEG would have an impact on that front, your thoughts or any information on those lines would be helpful.
One more question - You had mentioned in the earlier post about ‘‘balance sheet strength’’, with limited knowledge or rather no knowledge can you enlighten on what parameters would you normally keep an eye on while looking at the BS. Your inputs would help me.
Hi @pandi.rao, I am not a balance sheet expert either. I usually have quick look at the trends like steady improvement in company’s total reserves year-on-year, debt reductions year-on-year etc.
Chinese crackdown on the pollution was on the heavily polluting vehicles, factories and construction sites. As a result, several non-compliant and illegal steel mills, coal mines, aluminum smelters, and other manufacturing units were shut down.
There are two methods for steel making: 1)The Blast Furnace 2)The Electric Arc Furnace (EAF) method. Revenues for the Graphite electrodes producing companies depend only on the EAF method of steel making, as Graphite electrodes are used as one of the raw materials for the Electric Arc Furnaces.
The Blast Furnace method is highly polluting, as you burn coke, which delivers smoke and gases and all sorts of things that ruin the atmosphere. The EAF method is less polluting, as electricity is used to generate heat, instead of burning coke.
Chinese crackdown mainly happened on the steel making companies that followed the Blast Furnace method. China infact, furher increased its EAF capacity, ever since the pollution crackdown started. EAF usage world over is expected to increase replacing the Blast furnaces. In India, primarily EAF method is being followed for steel making.
Having said the above, there is always a risk of any highly polluting manufacturing facility without adequate air pollution control systems to be asked to be closed down by the Pollution Control Board at any time in India also.
Thanks @madhavikkutti for the details outlined, from the message above it looks like the future is tilting towards EAF and I am tempted to ask if there is a way to play that theme(EAF) in the listed space
Iron ore prices softening?
NMDC has reduced Lump Ore and Fine prices by Rs 100 per tonne wef 1.3.2018
The present price is Rs 3000/ and Rs 2660/- respectively.
It’s a small cut. Nothing major to be worried of. I m comfortable holding steel mining plays as long as Iron ore stays above 65$ mark on sustainable basis.
I believe, the most attractive EAF plays are the ones which we are already talking about - Graphite India and HEG
As per reports, after attending the 23-Feb Graphite Electrode (GE) Industry conference, Jefferies are expecting the prices of GE to be north of USD 10,000 per ton and the current spot prices in China are USD 25,000 per ton. The tight demand supply situation for GE is expected to continue for the next few years and prices will remain at elevated levels. Jeffereies has the latest target price for Graphite India as INR 1,135 and HEG, INR 3,622.
Please refer to what Graftech, world’s second largest producer of GE is telling its unitholders (https://bbu.brookfield.com/en/reports-and-filings/financial-reports/letters-to-unitholders-html/q42017lettertounitholders) after their Dec-17 results: “Given its industrial advantage and strong customer demand, GrafTech has successfully negotiated multi-year take-or-pay agreements for 60% to 65% of its production capacity over the next five years. The weighted average contract price over the next five years for contracted volume is $9,700 per metric tonne, which is approximately double historical average prices (although for a variety of reasons we expect go forward average pricing to be higher).”
Hence, even if we assume a GE price of USD 10,000 per ton and needle coke price of USD 2,000 per ton for FY19, I assume an EPS of around Rs 121 for Graphite India in FY19, which is 4.53 times the TTM EPS of Rs. 26.71.
Wondering what is impact on Indian
- Steel manufacturing companies
- Companies whose finished products are steel products and raw material is steel
- Aluminium manufacturing companies
- Companies whose finished products are Aluminium products and raw material is aluminium
@madhavikkutti Thanks for sharing the article. I can see that Aluminium imports from India to US has increased by 192 % in the last year. Do you think with this new tariff will impact NALCO’s or other Aluminium exporter’s share price ? @jitenp may be you can also share your views on this one ?
These are 5-yr. figures for NALCO.
It seems India is a net importer of aluminium. Or is it that the deficit is overcome by recycled metal. But it is clear that exports of aluminium from India to USA are only a small fraction of its total aluminium exports.
Source: Annual Report of NALCO 2017.
Hi @SD007, As per the following article, the impact will be minimum: https://www.google.co.in/amp/s/www.indiainfoline.com/article-amp/news-top-story/president-trump-considers-approving-harsh-import-duties-on-steel-and-aluminum-products-118022600022_1.html
In fact, it should be positive for Hindalco. Its US subsidiary Novelis is likely to see a sharp growth in both realization and volumes owing to the new protectionist measure by the US government.
Thanks @madhavikkutti for the pointers.
From your above table in the earlier post, assuming Graphite India negotiates the price to USD 8000 per ton and needle coke to USD 1600 for the future contracts the EPS comes upto 88, taking this figure into consideration the Forwad PE for FY19 comes upto 8 which looks pretty attractive from a valuation standpoint,
I believe you are also on the same consensus from an investment point of view, am I right in my interpretation.
Once again thanks for the pointers.