HEG: strong Buy

Long-term investments can be considered in the stock of HEG, a leading manufacturer of graphite electrodes in the country. The outlook for the company is strong on account of rising demand for graphite electrodes, an essential consumable used in steel production through the electric arc furnace (EAF) route. HEG's capacity additions, improving realisations, expansion in operating margins and access to captive power also inspire confidence. Despite the good prospects, the recent correction in the market has seen the stock fall steeply. The stock now trades at a very reasonable valuation of about 7 times its likely FY09 per share earnings, down from a peak of over 14 times.

Over the last four years, HEG has reported a compounded growth of over 11 per cent in revenues and 18 per cent in profits. This has primarily been helped by the improving price realisations on electrodes globally, supported by no significant additions in capacities in this sector. With the demand for graphite electrodes estimated to touch 1.34 million tonnes by 2010, good times may continue for HEG. For one, it has added significant capacities over the last few years and scaled up its facilities to about 57,000 million tonnes per annum. That no major capacities are likely to be added globally in the next few years may also help HEG benefit from the incremental demand. Second, global supply constraints have also driven the prices for electrodes higher. This is likely to help HEG realise better prices on its expanded capacities. Third, HEG's access to captive power of over 33 MW will help keep costs under control, as power accounts for a significant chunk of the total production cost. The company's prudence in controlling cost may help it cushion against any drop in realisations on graphite electrodes.

The company's last quarter results also reinforce its strong prospects. For the quarter ended December 2007, HEG reported a 140 per cent growth in earnings backed by a 38 per cent increase in revenues. Operating margins, during the period expanded by over 10 percentage points to 31 per cent. The availability of needle coke and HEG's ability to procure them on time hold the key to further growth.

Any unlocking in value of HEG's holding in Bhilwara Energy (39.13 per cent) can also be a potential trigger to the stock