whitemonk heg equity research report

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HEG BUY November 4, 2009

Dominant market share coupled with positive outlook of domestic steel sector makes it an attractive stock Country Sector

INDIA Electric Equipment

Category Large Cap Market Cap 11443.21M Enterprise Value 18129.11M FY09 Statistics Revenue 10990.9M Net Profit 1070M Operating Margin 26% Net Profit Margin 10% ROE 18% ROA 6% PE 10.88 Sector PE 9.2 P/BV 1.98 52- WEEK RANGE High INR284 Low INR94 Beta .53 Return Analysis One Month Return 4.49% Three Month Return 20.47% One Year Return 76.46%

*1 US$ = INR46.52

HEG PERFORMANC CHART (Price, Volume and Volatility)

Volume Data

3 – Month Avg. Daily Volume 26087

3-Month Avg. Daily Volume(in INR) 7130881

3-Month Avg. Daily Volume of total Market Cap

.06%

Equity Structure Promoters Holding :52.66% FII :10.45% MF :.2.64% Public :14.77%

EXECUTIVE SUMMARY Electrode and Graphite Sector: Each tonne of steel requires

about 2.5 kg of graphite electrodes and thus demand for graphite electrodes depends on steel production. The total size of domestic markets is estimated to be 26000-27000Tonnes per annum. HEG's market share within domestic market is around 42-43%. The World crude steel production for the month July 2009 stood at 103.9 million metric tons which is 11% lower when compared with corresponding period last year. The world crude steel production despite being a lower when compared with July 2008 figures, was the highest monthly production figure during the calendar year 2009.Overall outlook for steel sector is positive.

Company: HEG (BSE: 509631), is a large cap firms with market cap of 11443.7MN, manufactures graphite electrodes, which are used to produce steel from scrap by electric arc furnace (EAF) technology. The Company exports over 80% of its production to more than 25 countries worldwide. The Company's operations are organized into three business segments: graphite, steel/sponge and power. During the fiscal year ended March 31, 2009 (fiscal 2009), the production of graphite electrodes was 50,226 million tons. The company has a number of respected steel manufactures as clients such as ArcelorMittal, POSCO, US Steel, and Nucor

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.

Valuation Summary Price Weight

Relative Valuation

P/E 273.644 7.5%

EV/EBITDA 506.77 7.5%

Earning Power Valuation(EPV) 251.3 85.0%

Fair Price 272.22

Current Share Price 247

Recommendation: We recommend “BUY” at current share price

of INR247.


WhiteMonk Company Research Report – HEG

Key Performance Analysis

Any Loss in last Five Year No

Operating and Profit Margins

Good

Debt Exposure High, over 50% asset financed by Debt

Revenue Growth(5 years) 22%

ROE 18%

ROA 6%

Cash in Hand 64MN

Latest Quarter Results VS. FY08 Quarter

Revenue Growth Decreased by 2.15%

PAT Increased by 41.85%

Total Expenses Decreased by 1.8%

EPS Increased by 41.94%

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%

Cash in Hand 6.4

Debt as % of (Expense + Capex) 91%

Debt as % of Revenue 80%

Interest Coverage 4.1

WHY HEG IS A GOOD INVESTEMENT

The company has achieved revenue growth of 8% in 2009; In last five year overall revenue growth was 22%. Overall management has efficiently managed working capital and increased capital expenditure on a regular basis for capacity expansion. Its current ratio of Capex with respect to revenue is 13% which is highest in last three years and signifies that firms expect more demand in near term. In latest quarter, Management was able to drive down the expenses by 1.8% which resulted in significant PAT growth. We believe the company has higher financial risk; its debt is 50% of total asset and has lower interest coverage of 4.1. It is significantly higher than its peer’s leverage ratio which stands at 21.11%. The company‘s key financial performance is as given below:

What We liked:

HEG enjoys significant Market share in Electrode and Graphite sector along with good client base.

Good revenue growth in current economic downturn

Management has decreased the expense by 1.8% resulting in a significant PAT growth of 45%.



HEG’S PERFORMANCE COMPARISON WITH INDUSTRY

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.

RETURN ON DEPLOYED CAPITAL

PROFITABLITY ANALYSIS

ASSET UTILIZATION

FINANCIAL LEVEARGE



EPS AND DIVIDEND ANALYSIS

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.

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:

Year End

Dividend-Amount

Dividend Yield (%)

2009 27.43 6.88

2008 43.75 3.76

2007 20.16 3.01

2006 12.09 1.76

2005 12.09 2.09

2004 12.09 3.33

2003 8.87 8.35

2002 7.26 6.99

2001 8.06 6.78

-20%

-6%

89%79%

-23%-40%

-20%

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009

EPS % Growth(2005-09)



LIQUIDITY AND VOLATILITY ANALYSIS

It is a liquid stock. Below is liquidity analysis of the stock for last two years (2007-09)

Open Price High Price Low Price Close Price Total Volume

No. of 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 Summary Price Weight Summary

Relative Valuation

P/E 273.644 7.5% 10% Downside

EV/EBITDA 506.77 7.5% 105% upside

Earning Power Valuation(EPV) 251.4 85.0% 2% Upside

Fair Price 272.22


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

2. EV/EBITDA Based Valuation

Based on EV/EBITDA approach, we have valued HEG at INR506.77, on the basis of 2010 EBITDA of

INR5972M and EV/EBITDA multiple of 3.04.

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


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

We recommend HEG to investors as “BUY” at current price of INR247.

Please consider your position carefully ,once asset price appreciates by 25%-30%

In case share price falls, Please consider buying more so that your average cost of ownership

goes down.

Please diversify your portfolio, you may get less return in the short term, but it is always a

better and positive investing strategy to minimize overall market risk and maximize the returns

Please discuss your investment strategy with your financial advisor before making investment

decisions



EXHIBITS

EXHIBITS 1: ABBREVIATIONS

Abbreviations & Definitions

EPV Earning Power Value It is an estimate of the value of a company from its ongoing operations

Intrinsic Value

The intrinsic value (IV) of a potential investment is arrived at by comparing the results of the Net Asset Value (NAV) and Earnings Power Value (EPV)

NAV Net Asset Value

Replacement Value of the Assets, taking in to considerations of tangible and intangible assets such as customer relations, product portfolio and licenses.

CA Competitive Advantage It is net difference between EPV per share and replacement value of asset per share

Margin of Safety

It is the risk averse strategy in which, investor decides and apply a specific margin of safety to intrinsic value of the firm. Margin of safety depends upon firm revenue growth, management capability, and market share and risk appetite.

Entry Price

It is the intrinsic share value with margin of safety

PBT Profit Before Tax This captures the income-operating and non operating but before Tax

PAT Profit After Tax

This captures the income-operating and non operating but after Tax, Depending upon Industry, Tax Assets or Liability can affect overall profitability of the Firm

Operating Margin It’s a ratio of operating income to Sales.

Net Profit Margin It’s a ratio of Net income to Sales.

Beta It's measure of stock volatility against Stock market

Regression

Source Wiki:In statistics, regression analysis refers to techniques for modeling and analyzing several variables, when the focus is on the relationship between a dependent variable and one or more independent variables

Volatility It is pace through which stock prices moves up or down

ROE Return on Equity It’s a ratio of net income to Equity of the firm

ROA Return on Asset It’s a ratio of net income divided to Total Asset of the firm



EXHIBITS 2: RATIO ANALYSIS

2009 2008 2007 2006 2005

Sales Growth 8% 13% 55% 16% 18%

Operating Profit Margin 26% 31% 23% 22% 17%

Net Profit Margin 10% 15% 9% 7% 9%

ROE 18% 27% 21% 12% 14%

ROA 6% 10% 5% 3% 5%

Current Ratio 6.5 6.6 5.9 6.7 3.1

D/E 1.5 1.3 2.5 2.5 1.5

D/A 0.521 0.5 0.6 0.6 0.5

A/R Turnover 3.2 3.4 4.3 4.5 4.5

Days of sales outstanding 113.9 107.5 85.5 80.8 81.3

Inventory Turnover 1.7 2.2 2.1 1.9 3.0

Inventory Turnover days 213.1 167.7 174.1 190.7 120.6

Operating Cash Flow growth -24% 193% -166% -171% -22%

Capex as % of Sales 13% 5% 7% 23% 60%

Cash in Hand 6.4 43.2 103.3 130.5 20.3 Debt as % of (Expense + Capex) 91% 95% 121% 135% 68%

Debt as % of Revenue 80% 71% 101% 136% 99%

Interest Coverage 4.1 5.7 3.7 4.3 8.1



EXHIBITS 3: REGRESSION ANALYSIS

HEG VS SENSEX (1 YEAR RETURN ANALYSIS)

y = 0.5439x + 0.0016R² = 0.2564

-15%

-10%

-5%

0%

5%

10%

15%

20%

-20% -10% 0% 10% 20%

Heg Vs. Sensex

Heg

Linear (Heg)



EXHIBITS 4: INCOME STATEMENT

*All Figures are in INR-M

2009 2008 2007 2006 2005

INCOME :

Sales Turnover 10529.8 9790 8675.3 5604 4818.2

Excise Duty 272.4 321.1 521.5 361.3 262.1

Net Sales 10257.4 9468.9 8153.8 5242.7 4556.1

Other Income 171.5 337.5 281.7 99.1 64

Stock Adjustments 562 251.5 353 565.3 -31.5

Total Income 10990.9 10057.9 8788.5 5907.1 4588.6

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



EXHIBITS 5: BALANCE SHEET


2009 2008 2007 2006 2005

Inventories 409.73 273.38 280.89 214.13 104.35

Sundry Debtors 328.54 288.35 203.13 124.04 107.27

Cash and Bank 6.38 43.19 103.25 130.47 20.32

Loans and Advances 162.69 212.05 131.21 115.7 66.49

Total Current Assets 907.34 816.97 718.48 584.34 298.43

Gross Block 853.46 795.03 917.33 849.18 551.53

Less : Accumulated Depreciation 289.44 246.26 267.49 221.35 184.11

Less: Impairment of Assets Net Block 564.02 548.77 649.84 627.83 367.42

Capital Work in Progress 134.23 56.47 23.14 35.69 210.8

Investments 83.54 30.32 56.46 30.14 30.14

Miscellaneous Expenses not written off 1.39 2.43 3.47 4.52 0

Deferred Tax Assets 3.75 2.34 3.51 6 3.6

Total Asset 1694.27 1457.3 1454.9 1288.52 910.39

Current Liabilities 89.54 88.89 74.59 65.98 76.12

Provisions 50.43 35.48 47.31 21.51 19.12

Total Current Liabilities 139.97 124.37 121.9 87.49 95.24

Deferred Tax Liability 78.73 75.96 87 75.52 64.92

Secured Loans 664.09 617.45 724.42 669.05 441.7

Unsecured Loans 217.95 94.32 163.4 135.93 13.15

Total Debt 882.04 711.77 887.82 804.98 454.85

Share Capital 42.57 44.32 40.31 40.31 40.31

Reserves Total 533.7 483.44 317.87 280.22 255.07

Equity Share Warrants 17.26 17.44 0 0 0

Total Shareholders Funds 593.53 545.2 358.18 320.53 295.38

Total Liability 1694.27 1457.3 1454.9 1288.52 910.39



EXHIBITS 6: CASH FLOW


2009 2008 2007 2006 2005

Cash Flow Summary

Cash and Cash Equivalents at Beginning of the year 431.9 1032.5 1304.7 203.2 143.8

Net Cash from Operating Activities 674.9 891.9 304.8 -459.1 643.2

Cash Flow From Operating Activities 0 0 0 0 0

Net Profit before Tax & Extraordinary Items 1613.9 2072 1000.7 530.1 496.1

Adjustment For Depreciation 455.5 450.9 476.4 396.2 243.2

Interest (Net) 561.2 428.1 386.7 237.6 93.2

Dividend Received -1.8 -0.3 0 -0.3 -1.6

P/L on Sales of Assets -28.1 -137.4 -0.9 -6.2 -0.6

P/L on Sales of Invest 0 0 0 0 0

Prov. & W/O (Net) 10.4 10.4 9.9 7 10.6

P/L in Forex Fin. Lease & Rental Chrgs Others 17.8 -0.6 0 0 0

Total Adjustments (PBT & Extraordinary Items) 1015 751.1 872.1 634.3 344.8

Op. Profit before Working Capital Changes 2628.9 2823.1 1872.8 1164.4 840.9

Adjustment For Trade & 0th receivables -401.9 -852.2 -790.9 -167.7 -111.8

Inventories -1363.4 75.1 -667.6 -1097.8 -100.2

Trade Payables 29.3 146.8 217.9 88.9 98.2

Loans & Advances 312.3 -593.6 -204.8 -388.2 -22.1

Others 0 0 0 0 0

Total (OP before Working Capital Changes) -1423.7 -1223.9 -1445.4 -1564.8 -135.9

Cash Generated from/(used in) Operations 1205.2 1599.2 427.4 -400.4 705

Interest Paid(Net) Direct Taxes Paid -530.3 -707.3 -122.6 -58.7 -61.8

Advance Tax Paid Others Total-others -530.3 -707.3 -122.6 -58.7 -61.8

Cash Flow before Extraordinary Items 674.9 891.9 304.8 -459.1 643.2

Extraordinary Items Net Cash Used in Investing Activities -1550.2 413.8 -709.1 -1462.5 -2376.1

Net Cash Used in Financing Activities 507.2 -1906.3 132.1 3023.1 1792.3



DISCLOSURES AND DISC LAIMER

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The Director of Research and Analysis at White Monk Research & Analysis Private Limited (White Monk), certifies that the views expressed in this research report accurately reflect his personal views about the subject securities and issuers. No part of White Monk compensation is or will be directly related to the specific recommendations or views contained in this research report.

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whitemonk heg equity research report

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