Company Update | Capital Goods

November 14, 2011

HEG
Performance Highlights
Y/E March (` cr) Net sales EBITDA EBITDA margin (%) Reported PAT
Source: Company, Angel Research

BUY
CMP Target Price
2QFY11 300 60 20.1 30 % chg (yoy) 6.5 (45.8) (987bp) (54.5) 1QFY12 279 44 15.8 20 % diff 14.2 (26.1) (557bp) (31.5)

`195 `238
12 Months

2QFY12 319 33 10.2 14

Investment Period
Stock Info Sector Market Cap (` cr) Beta 52 Week High / Low Avg. Daily Volume Face Value (`) BSE Sensex Nifty Reuters Code Bloomberg Code

HEG reported revenue growth of 6.5% yoy to `319cr during 2QFY2012. EBITDA margin contracted by 987bp yoy to 10.2% due to a 27% yoy increase in raw-material cost and forex loss of `11.6cr. On the profitability front, HEG reported a decline of 54.5% yoy to `14cr in 2QFY2012 as compared to profit of `30cr in 2QFY2011. We maintain our Buy recommendation on the stock. OPM impacted by increased raw-material costs and forex losses: During 2QFY2012, HEG reported net sales growth of 6.5% yoy to `319cr. The companys EBITDA margin came in at 10.2% in 2QFY2012, down 987bp yoy from 20.1% in 2QFY2011, on the back of higher raw-material costs and forex loss. On the bottom-line front, HEG reported a 54.5% decline to `14cr from `30cr in 2QFY2011. Outlook and valuation: We expect HEGs revenue to grow at a 25% CAGR over FY2011-13E, aided by higher prices of graphite electrodes. The companys EBITDA margin is expected to witness a downward trend in FY2012E and FY2013E due to higher raw-material prices and INR depreciation. However, PAT is expected to rebound to `134cr in FY2013E from `123cr in FY2011 and `63cr in FY2012E. At `195, HEG is trading at PE of 5.9x its FY2013E earnings and P/B of 0.8x for FY2013E. We maintain our Buy recommendation on the stock with a target price of `238, based on a target P/B of 1.0x for FY2013E.

Cap Goods 791 0.4 176 / 292 17,637 2 17,119 5,148 HEGL.BO HEG IN

Shareholding Pattern (%) Promoters MF / Banks / Indian Fls FII / NRIs / OCBs Indian Public / Others 55.3 10.9 17.9 15.9

Abs. (%) Sensex HEG

3m 0.8

1yr (16.5)

3yr 74.7 40.1

(10.3) (29.9)

Key financials
Y/E March (` cr) Net sales % chg Net profit % chg EBITDA margin (%) EPS (`) P/E (x) P/BV (x) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x)
Source: Company, Angel Research

FY2010 1,131 10.3 189 0.5 29.9 44.3 4.2 1.0 26.5 20.9 1.2 4.0

FY2011 1,114 (1.5) 123 (34.9) 20.1 29.7 6.4 0.9 14.1 11.0 1.3 6.7

FY2012E 1,358 21.9 63 (48.5) 13.2 15.6 12.5 0.9 7.1 6.3 1.3 10.1

FY2013E 1,728 27.2 134 111.6 17.0 33.1 5.9 0.8 14.6 10.8 1.1 6.3

Shareen Batatawala
+91- 22- 3935 7800 Ext: 6849 shareen.batatawala@angelbroking.com

Please refer to important disclosures at the end of this report

HEG | Company Update

Exhibit 1: 2QFY2012 performance

Y/E March (` cr) Net Sales Net raw material (% of Sales) Staff Costs (% of Sales) Power and fuel expenses (% of Sales) Other Expenses (% of Sales) Total Expenditure Operating Profit OPM Interest Depreciation Other Income PBT (% of Sales) Tax (% of PBT) Reported PAT PATM Equity capital (cr) EPS (`)
Source: Company, Angel Research

2QFY2012 319 169 52.9 11 3.4 20 6.2 87 27.3 287 33 10.2 8 14 3.8 15 4.6 1 6.9 14 4.2 41 3.3

2QFY2011 300 133 44.3 10 3.5 21 6.9 76 25.2 239 60 20.1 9 14 4.4 42 14.2 13 30.0 30 9.9 41 7.3

yoy chg (%) 6.5 27.3 2.5 (4.2) 15.2 19.7 (45.8) (8.9) 3.6 (14.1) (65.7) (92.1) (54.5)

1QFY2012 279 132 47.2 11 4.0 29 10.2 64 22.8 235 44 15.8 8 14 2.5 25 8.9 5 21.0 20 7.1 41

qoq chg (%) 14.2 28.2 (5.3) (30.6) 36.6 21.7 (26.1) (1.4) 2.3 48.8 (41.8) (80.7) (31.5)

1HFY2012 599 301 50.2 22 3.7 48 8.1 151 25.2 522 77 12.8 16 28 6 40 6.6 6 15.8 33 5.6 41

1H20FY11 522 221 36.9 21 3.5 36 6.9 127 24.3 405 117 22.5 18 29 6 77 14.8 21 26.9 56 10.8 41 13.9

% chg 14.7 36.1 6.6 33.8 19.0 29.0 (34.6) (11.0) (4.3) (1.1) 12.6 (69.8) (40.8)

(54.5)

4.9

(31.5)

8.2

(40.8)

OPM affected by higher raw-material costs

HEG reported a 6.5% increase in its revenue to `319cr in 2QFY2012 from `300cr in 2QFY2011. The companys EBITDA margin witnessed a decline of 987bp yoy as compared to 2QFY2011 on the back of a 27% yoy increase in raw-material costs along with forex loss of `11.6cr. The companys profit came in at `14cr in 2QFY2012, 54.5% lower as compared to `30cr in 2QFY2011. Tax rate for the quarter was extremely low at 6.9% due to higher revenue contribution from the thermal power plant, which is in the tax-free zone.

November 14, 2011

HEG | Company Update

Investment rationale
Higher price of graphite electrodes to lead to recovery
Global graphite electrode players had increased their product prices by 40-50% in 1HFY2012, whereas HEG could not increase its prices since the companys price revision is carried on a calendar year basis. Management has guided a gradual increase in graphite electrode prices for the company, which is expected to lead to a recovery in the companys profitability going forward.

Competitive advantage of being the lowest cost producer

HEG is the lowest cost producer of graphite electrodes in the world, with the largest single site installed capacity of 80,000 tonnes per annum (TPA). This is mainly because the company uses captive power, which is cost efficient. Power cost constituted ~26% of the companys total expenditure in FY2011.

HEGs investment in Bhilwara Energy Ltd. to add value

HEG has a 25.8% stake in Bhilwara Energy Ltd. (BEL), which operates in the power business and currently has 270MW of power plants operational. The company invested `26cr for 2.62cr equity shares of BEL which increased to 3.91cr in FY2010 on account of 1:2 bonus issue; and `40cr for 4 lakh preference shares of BEL in FY2010. BEL had a net worth of `225cr as of March 2010. Also, IFCs investment in BEL for 10.8% stake at `230cr valued the company at `2,173cr, which makes HEGs investment in the company at ~`560cr. We have not factored the same in our estimates.

November 14, 2011

HEG | Company Update

Assumptions
Exhibit 2: Key assumptions
FY2012E Change in raw-material price (%) Change in the MRP of graphite electrodes (%)
Source: Angel Research

FY2013E 20.0 17.7

60.0 12.0

Exhibit 3: Change in estimates

Y/E March Net sales (` cr) OPM (%) EPS (`)
Source: Angel Research

Earlier estimates FY2012E 1321 20.3 33.1 FY2013E 1503 24.0 48.1

Revised estimates FY2012E 1358 13.2 15.6 FY2013E 1728 17.0 33.1

% chg FY2012E 2.7 (716) (52.8) FY2013E 14.9 (702) (31.2)

Key highlights of the conference call

The increase in raw-material costs during the quarter can be attributed to higher prices of petro products and INR depreciation, which led to higher needle coke prices in INR terms. Needle coke prices in USD terms, however, remained constant. Prices of graphite electrodes have increased by 40-45% globally, but the company has not been able to pass on the prices since the price revision takes place on a calendar year basis. Capacity utilization for 1HFY2012 stood at over 85%. Expanded capacity will be operational by the end of November 2011. The company has incurred capex of ~`150cr for 1HFY2012, while `75cr is pending for 2HFY2012. Tax rate for the quarter was lower at 7% due to higher contribution from the thermal power plant, which is in the tax-free zone.

November 14, 2011

HEG | Company Update

Financial performance
We expect HEG to post revenue CAGR of 25% over FY2011-13E, from `1,114cr in FY2011 to `1,728cr in FY2013E, on the back of commencement of increased capacity and higher prices of graphite electrodes. The companys EBITDA margin is expected to contract by 281bp in FY2013E due to higher domestic raw-material prices and other expenses on account of commencement of additional capacity in 3QFY2012E. The companys earnings are expected to rebound to `134cr in FY2013E from `123cr and `63cr in FY2011 and FY2012E, respectively.

Exhibit 4: Revenue and revenue growth

2,000 1,800 1,600 1,400 1,200 30 25 20

(` cr)

1,000 800 600 400 200 0 FY2008 FY2009 FY2010 Revenue FY2011 FY2012E FY2013E Revenue growth

10 5 0 -5

Source: Company, Angel Research

Exhibit 5: EBITDA and EBITDA margin

400 350 300 250 35 30 25

Exhibit 6: PAT and PAT growth

200 160 120 80 40 0 FY2008 FY2009 FY2010 PAT FY2011 FY2012E FY2013E PAT growth 130 100 70 40 10 -20 -50

(` cr)

(` cr)

150 100 50 0 FY2008 FY2009 FY2010 EBITDA FY2011 FY2012E EBITDA margin FY2013E

15 10 5 0

Source: Company, Angel Research

(%)

200

Source: Company, Angel Research

November 14, 2011

(%)

20

(%)

15

HEG | Company Update

Outlook and valuation

We have revised our revenue estimates upwards due to increased prices of graphite electrodes globally; however, we have reduced our earnings estimates, considering the increase in domestic (petro-products) and international (needle coke) raw-material prices. At current levels, the stock is trading at PE of 5.9x FY2013E and P/B of 0.8x for FY2013E. We maintain our Buy recommendation on the stock with a target price of `238, based on a target P/B of 1.0x for FY2013E.

Exhibit 7: One-year forward P/B

700 600 500 400

(`)

300 200 100 0 Nov-06 Nov-07 Price Nov-08 0.5x Nov-09 1.0x 1.5x Nov-10 2.0x Nov-11

Source: Company, Angel Research

Exhibit 8: Relative valuation

Company (TTM) HEG Graphite India
Source: Company

Sales (` cr)

OPM PAT (%) (` cr) 106 168

EPS (`) 8.6

ROE (%)

P/E P/BV (x) (x) 0.9 0.9

EV/ EBITDA (x) 8.3 5.7

EV/ Sales (x) 1.4 1.1

1,191 17.2 1,421 18.9

26.1 13.5 7.1 13.0 8.6

November 14, 2011

HEG | Company Update

Risks
Foreign exchange risk
For FY2011, 50% of the companys total loan was foreign currency loan, whose interest rate was very low at 4% for FY2011. Depreciation in the currency has led to forex loss of `11.6cr for 2QFY2012. Also, needle coke (major raw material in the manufacturing of graphite electrodes) prices have been constant in USD terms, but INR depreciation has led to an increase in needle coke prices. Any further depreciation in the INR would impact the companys profitability going ahead.

Rising raw-material costs

Domestic raw-material prices increased by 27% yoy in 2QFY2012, while for 1HFY2012, prices have increased by 36% yoy as compared to 1HFY2011. Higher raw-material costs have led to a decline in the companys OPM. Any further increase in raw-material costs will have impact the companys profitability.

Exhibit 9: Impact of raw-material prices on OPM

60 50 40

(%)

30 20 10 0

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

1QFY12

Raw material (% of sales)

Source: Company

EBITDA margin

November 14, 2011

2QFY12

HEG | Company Update

The industry
Graphite electrodes are used in electric arc furnace (EAF) based steel mills. The EAF method of manufacturing steel is attractive due to low capital costs; lower breakeven tonnage; flexibility in locating plants closer to consumption points; and significantly lower pollution level than that in blast furnace steel plants. EAF production has increased from 114mn tonnes in 1975 to 396mn tonnes in 2010.

Exhibit 10: Steel production through EAF method

1,500 1,200 40

30

(mn tonnes)

900 20 600 300 0 1975 1980 1985 1990 EAF 1995 2004 2010 Total Steel % EAF in total steel 10

Source: Industry data

The graphite industry is highly consolidated, as the top five major global players make up 75% of the high-end ultra-high power (UHP) electrode capacity. These players are located in high-cost regions such as US, Europe and Japan. Graphite electrodes cannot be substituted by any other material and constitute ~2% of the total steel production. The graphite industry is not impacted by steel prices but is impacted by the volume of steel produced.

The company
HEG is a leading manufacturer and exporter of graphite electrodes, which are used in the EAF method of steel production. The company has the largest single site plant of 66,000MTPA capacity for graphite electrodes, which is planned to be expanded to 80,000 MTPA. For FY2011, HEGs capacity utilization stood at 85%. HEG vertically integrated into power generation with a capacity of 77MW (contributed ~17.6% to the total revenue in FY2011), excess of which is sold. HEG has a diversified customer portfolio comprising POSCO, US Steel, Arcelor Mittal, Krupp Thyssen, Nucor, Usinor, SAIL, TISCO, Jindal and Hyundai, among others. In FY2011, exports contributed about 80% to the companys revenue. The company bought back fully paid equity shares from the open market for an amount of `67.5cr, which is 9.95% of total paid-up capital and free reserves, as of March 2010. The promoters stake in the company has increased from 52.28% in March 2011 to 55.3% in September 2011, by extinguishing 23.46lakh equity shares from the market.

November 14, 2011

(%)

HEG | Company Update

Profit & Loss Statement

Y/E March (` cr) FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E

Gross sales
Less: Excise duty Net Sales Total operating income % chg Net Raw Materials Other Mfg costs Power and Fuel costs Personnel Other Total Expenditure EBITDA % chg (% of Net Sales) Depreciation & Amortisation EBIT % chg (% of Net Sales) Interest & other Charges Other Income (% of Net sales) PBT % change Tax (% of PBT) PAT (reported) ADJ. PAT % chg (% of Net Sales) Basic EPS (`) Adjusted EPS (`) % chg

979 1,053
32 947 947 16.1 267 66 184 35 123 675 272 56.9 28.7 45 227 80.5 23.9 54 34 3.6 207 107.1 61 29.4 146 146 95.6 15.4 32.6 32.6 77.9 27 1,026 1,026 8.3 212 66 175 37 250 741 285 (5.7) 27.8 46 239 (7.0) 23.3 67 17 1.7 190 (22.1) 54 28.7 135 135 30.2 13.2 43.9 43.9 34.8

1,153
21 1,131 1,131 10.3 365 94 169 39 144 811 320 31.6 28.3 51 269 35.6 23.7 59 15 1.3 224 50.1 71 31.7 153 153 0.5 13.5 44.3 44.3 1.0

1,136
23 1,114 1,114 (1.5) 332 76 232 44 152 836 277 (33.8) 24.9 57 220 (42.0) 19.7 37 38 3.5 222 (30.6) 39 17.7 182 182 (34.9) 16.4 29.7 29.7 (33.0)

1,385
27 1,358 1,358 21.9 558 115 266 50 190 1,179 179 (20.1) 13.2 66 113 (32.2) 8.3 45 16 1.2 83 (50.4) 20 24.0 63 63 (48.5) 4.7 15.6 15.6 (47.3)

1,762
35 1728 1,728 27.2 638 142 340 73 242 1,434 293 64.1 17.0 77 217 92.3 12.5 57 19 1.1 179 114.4 45 25.0 134 134 111.6 7.8 33.1 33.1 111.6

November 14, 2011

HEG | Company Update

Balance Sheet
Y/E March (` cr) SOURCES OF FUNDS Equity Share Capital Reserves & Surplus Equity share warrants Shareholders Funds Total Loans Deferred Tax Liability Total Liabilities APPLICATION OF FUNDS Gross Block Less: Acc. Depreciation Net Block Capital Work-in-Progress Goodwill Investments Current Assets Cash Loans & Advances Inventory Debtors Current liabilities 795 246 549 56 30 817 43 212 273 288 124 853 289 564 134 84 907 6 163 410 329 140 995 337 658 58 169 912 4 124 343 440 159 1,044 386 659 79 196 1108 12 192 510 395 147 1,319 452 868 30 196 1296 12 199 626 460 216 1,346 528 817 30 196 1526 14 247 707 558 267 44 483 17 545 712 74 1,331 43 534 17 594 882 75 1,551 43 790 833 731 75 1,638 43 868 910 910 74 1,894 41 830 871 1229 74 2,173 41 922 962 1266 74 2,302 FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E

Net Current Assets

Mis. Exp. not written off Total Assets

693
2 1,331

767
1 1,551

753
1,638

961
1,894

1,080
2,173

1,259
2,302

November 14, 2011

10

HEG | Company Update

Cash Flow Statement

Y/E March (` cr) Profit before tax Depreciation Change in Working Capital Other income Direct taxes paid Cash Flow from Operations (Inc.)/Dec. in Fixed Assets (Inc.)/Dec. in Investments Dividend received Interest received Others Cash Flow from Investing Issue of Equity Inc./(Dec.) in loans Dividend Paid (Incl. Tax) Interest paid Others Cash Flow from Financing Inc./(Dec.) in Cash Opening Cash balances Closing Cash balances FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E 207 45 (156) 54 (61) 89 89 26 11 (85) 41 4 (176) 44 54 (116) (191) (60) 103 43 161 46 (112) 27 (54) 67 (136) (53) 11 23 (155) (2) 170 27 67 (212) 51 (37) 43 6 242 51 12 69 (71) 304 (65) (85) 1 100 (49) (151) 43 59 (207) (256) (2) 6 4 168 57 (201) 67 (39) 53 (70) (27) 1 1 (48) (143) 180 43 37 (161) 98 7 4 12 83 66 (119) 29 (20) 40 (226) (76) (302) (2) 319 41 45 (140) 262 12 12 179 77 (176) 38 (45) 73 (26) (36) (63) 37 43 57 (144) (7) 3 12 14

November 14, 2011

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HEG | Company Update

Key Ratios
Y/E March Valuation Ratio (x) P/E (on FDEPS) P/CEPS P/BV Dividend yield (%) EV/Sales EV/EBITDA EV / Total Assets Per Share Data (`) EPS (Basic) EPS (fully diluted) Cash EPS DPS Book Value Dupont Analysis EBIT margin Tax retention ratio Asset turnover (x) ROIC (Post-tax) Cost of Debt (Post Tax) Leverage (x) Operating ROE Returns (%) ROCE (Pre-tax) Angel ROIC (Pre-tax) ROE Turnover ratios (x) Asset Turnover Inventory / Sales (days) Receivables (days) Payables (days) WC (ex-cash) (days) Solvency ratios (x) Net debt to equity Net debt to EBITDA Interest Coverage 1.2 2.3 4.2 1.3 3.1 3.2 0.7 1.7 4.8 0.8 3.1 4.5 1.2 5.7 2.5 1.1 3.6 3.8 1.1 107 95 67 220 1.2 122 110 63 251 1.2 121 124 69 244 1.1 140 137 63 278 1.1 153 124 67 271 1.3 141 118 68 244 17.0 19.3 31.9 14.6 16.7 33.0 17.9 20.9 26.5 9.4 11.0 14.1 5.5 6.3 7.1 9.7 10.8 14.6 24.0 0.7 0.8 13.3 4.7 1.2 23.4 20.6 0.7 0.8 10.5 5.6 1.3 17.1 25.3 0.7 0.8 14.3 5.2 0.7 20.5 14.9 0.8 0.7 7.9 3.4 0.8 11.4 8.3 0.8 0.7 4.4 3.2 1.2 5.8 12.5 0.8 0.8 7.9 3.4 1.1 12.7 32.6 32.6 42.7 9.9 123.0 43.9 43.9 54.5 6.4 138.6 44.3 44.3 56.4 10.1 195.4 29.7 29.7 43.5 10.3 219.9 15.6 15.6 31.9 10.0 215.0 33.1 33.1 52.0 10.5 237.6 5.5 4.2 1.5 5.5 1.5 5.3 1.1 4.2 3.4 1.3 3.5 1.5 6.2 1.0 4.2 3.3 1.0 5.4 1.2 4.0 0.8 6.4 4.4 0.9 5.4 1.3 6.7 0.8 12.5 6.1 0.9 5.1 1.3 10.1 0.8 5.9 3.8 0.8 5.4 1.1 6.3 0.8 FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E

November 14, 2011

12

HEG | Company Update

Research Team Tel: 022 - 39357800

E-mail: research@angelbroking.com

Website: www.angelbroking.com

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 Broking 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, but we do not represent that it is accurate or complete and it should not be relied on as such, as this document is for general guidance only. Angel Broking Limited or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. Angel Broking 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 Broking 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 Broking 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 Broking 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). Also, please refer to the latest update on respective stocks for the disclosure status in respect of those stocks. Angel Broking Limited and its affiliates may have investment positions in the stocks recommended in this report.

Disclosure of Interest Statement 1. Analyst ownership of the stock 2. Angel and its Group companies ownership of the stock 3. Angel and its Group companies' Directors ownership of the stock 4. Broking relationship with company covered

HEG Ltd. No No No No

Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors

Ratings (Returns):

Buy (> 15%) Reduce (-5% to 15%)

Accumulate (5% to 15%) Sell (< -15%)

Neutral (-5 to 5%)

November 14, 2011

13