These 2 stocks have seen a significant increase over the period of last 2 years. HEG which had a price of around Rs. 150 is now being traded at close to Rs. 4,000. The growth seems to be around 25 times. HEG saw around 2,500% increase in its stock price. And Graphite India stock which was around Rs. 75 is now priced around Rs. 850. Here, the growth is almost 11 times and the percentage increase is close to 1,000%.
What happened that these companies saw such significant rises? What are the reason behind this increase?
Steel Production – Changes in China
Whatever production of steel that takes place in China is done through old methods using coal plants and similar things. This results in excessive pollution. In 2016, China started taking pollution control measures aggressively. For this China claimed that the production that will happen using the ‘Electric Arc Furnace Technology’ will result in lower pollution. This Electric Arc Furnace Technology which uses graphite electrode for steel production result in almost 80% less pollution. All over the world, there are 5 major players in this technology production, and out of these 5, 2 are from India who are in this type of production. So, almost 20% of the global capacity to produce graphite electrode is present in India. This acted as a booster for these companies (HEG & Graphite India). This resulted in a multi-fold growth in the sales of these companies in the last 2 years.
In March 2017, HEG declared a loss of Rs 50 crores but the current trailing twelve-month profits of the company amount to around Rs. 2,600 crores. Once where this company was a loss making one, is now making huge profits in just 2 years. In the future too, they seem to have clear visibility in earnings with scope to grow more.
That is exactly why these stocks have increased so much.
The Price-to-Earnings (PE) ratio of these companies ranges between 5 to 6. The Price-to-Earning Growth (PEG) Ratio (PE ÷ Growth) is also a very important factor. Other companies have high PEG ranging between 5-9. But, the PEG of these companies ranges around 0.13. This is so because the growth they saw in the last 2 years was a phenomenal growth and that kind of (high) PE hasn’t been given to these companies. One would say that even with such clear visible growths, why haven’t these companies been given higher PE’s. The reason behind is that there were no global player focusing on graphite electrodes. But when this market starts to grow gradually, then this market would get open to all to enter. And Chinese companies particularly will definitely enter this market of graphite electrode production. Obviously, many things will also be dependent on the raw materials involved in this. But there are chance of China entering into this. This why the analyst are not ready to give these companies PE’s higher than this. They will only get higher valuations if they concentrate on their growth and profitability. If the companies maintain 20-25% growth, then maybe they may get expected valuations.
Lack of visibility of earnings and many uncertainties are the main reason behind these companies getting these rational PE values.
The steel that was being imported from China, has now been charged with import duty by the government. That has led to increased production in Indian companies and the companies are seeing higher demands for them. Majority of steel production in India is done using the electric arc furnace technology. Thus, this is an advantage to the HEG and Graphite India (as they are the suppliers of graphite electrode which are required in electric arc furnace technology).
But there are claims that there many entry barriers in this business. But if China wants, it can easily enter this business and set up such companies of itself. And with their increasing focus on pollution control measures, it can definitely come up with alternative solutions.