Graphite India Ltd. (Rs.50/-) March 23, 2007

A VALUE BUY WITH HIGH ENTRY BARRIER. Graphite India Ltd. (Rs. 50/-, Rs. 2/- F.V.): GIL is promoted by the K K Bangur Group and is headquartered in Kolkatta. Incorporated in 1963 in collaboration with The Great Lakes Carbon Corporation of USA, GIL set up its first plant at Durgapur in West Bengal in 1967. The company acquired two calcined petroleum coke units in 1994. Under the amalgamation scheme, the company merged itself with Carbon Everflow in April 2001 to become a prominent producer of graphite electrodes in South Asia. It now contributes to 8.3% of the total global graphite output. Currently, GIL has a combined capacity of 75,000 MT p.a. spread over four plants at Durgapur, Bangalore, Nashik and Germany. GIL exports 70% of its electrodes to South America, North America, Europe, South East Asia, and the Middle East. The company has backward integration in the manufacturing chain through a 33 MW captive power plant and a 30,000 MT calcined petroleum coke facility. Business Segments: The company operates across the following business segments: Graphite Electrodes: Graphite Electrode is a device which conducts electricity down into an electric arc furnace, generating sufficient heat to melt scrap steel. There is no commercially viable substitute for Graphite Electrodes in EAF steel making process. Worldwide, EAF steel production grew from about 90 mn MT in 1970 to 358 mn MT in 2005. Global steel production through the Electric Arc Furnace (EAF) route is expected to rise to 43% by 2010E from about 35% of total steel production in 2005. Consumption of Graphite Electrodes is 2.5 kg. per tonne of steel through EAF, whereas the consumption is only 0.5 kg. per tonne of steel in ladle furnaces for refining the liquid metal. GIL manufactures Ultra High Power Electrodes (UHP), High Power (HP) and Regular Power (RP) Grades of Electrodes. Of these, UHP Grade of Electrodes, which are higher value-added products, constitute 80% of total Graphite Electrodes manufactured. GIL's key clients in India include Essar Steel, Ispat Industries, TISCO, SAIL, Indian Seamless Steel, Jindal Stainless Steel whereas globally, GIL supplies to Arcelor-Mittal, Nucor, POSCO and Qatar Steel to name a few. Impervious Graphite Equipment: This division manufactures value-added products like Heat Exchangers, Ejectors, Pumps, and Turnkey Plants which have wide applications in corrosive chemical industries such as pharmaceuticals, agro chemicals and fertilizers. GIL also provides turnkey services comprising equipment design, critical engineering and plant layout, product manufacture, installation, commissioning and customer training. This division is located at Nashik with a capacity of 650 MT p.a. Carbon Electrode Paste (CEP): CEP is used as a conductor while manufacturing different types of ferro alloys, carbide, and metal cleaning. This division has a capacity of 25,000 MT p.a. Calcined Pet Coke (CPC): It is the key R/M used in the manufacture of regular and high power grade graphite electrodes. This is also a critical raw material for fine grained high density mold stock used in specialty graphite products and impervious graphite equipments. The CPC Unit is located at Barauni in Bihar and has a 30,000 MT capacity. Of the total CPC production, 50% is consumed in house, whereas 50% is sold outside.

GRP/FRP Pipes and Tanks: GRP Pipes are used for sewerage, transportation of water, sea water and effluent waste, whereas GRP tanks are used for storage of flammable fluids in the petroleum industry. Compared to cast iron, ductile iron pipes or mild steel pipes, GRP pipes are lighter, corrosion resistant, and easier to install. Located in Nashik, GIL has a capacity of 10,000 MT p.a. Power: Electricity is one of the key R/M other than Coke. To produce 1 tonne of Graphite Electrode about 5,000 - 5,500 units of power is required. The company has a capacity to produce 33 MW of Power. Of this, it generates 19.5 MW through Hydel, while the rest is multi-fuel. Hydel Power is produced mainly during monsoons, which is then drawn down from the grid throughout the year. With the presence of a Hydel Plant in Karnataka, the cost of manufacturing power in-house is as low as INR 0.80 per unit. German Acquisition: In 2HFY05, the Company has acquired the assets relating to production of Graphite Electrodes, coating of electrodes and specialties business in Germany of Conradty Group, through its wholly owned foreign subsidiaries, for a cost of Euro 11.3 mn. It has since been renamed as Graphite Cova GmbH. The German acquisition is a significant positive for the company as it helps the company to work around the anti-dumping duty imposed by the EU on Graphite Electrodes of Indian origin. The duty of 15.7% led to an outgo of Rs. 8 cr. for the company in FY05. Anti-dumping duties are levied against a country and not a company, so by routing its final product through the German subsidiary, GIL can supply to the European markets at a relatively lower cost. These capacity additions put together have increased GIL's capacity to 75,000 TPA, making it the fourth largest Electrode manufacturer in the world. GIL is already in the process of adding another 10,000 MT capacity by de-bottlenecking the German facility and this is expected to be commissioned by 1QFY09. Industry Scenario: ...Improving export prospects for Indian Companies: The contraction in availability of Graphite Electrodes due to closure of some capacities has favourably impacted Indian Companies (GIL and HEG), which have relatively lower costs. Indian Companies compare favourably with their Western counterparts mainly on the employee cost front, which is much lower for the former. Proximity to the high growth Asian markets is an added advantage for GIL and HEG. Supply: The estimated world capacity for the manufacture of Graphite Electrodes is around 1mn TPA with the principal manufacturers based in USA, Europe, Japan, India and China. In terms of competition, there are only seven large players in the Graphite Electrode Market globally. The big two, SGL Carbon and GrafTech International have an installed capacity of over 2,00,000 MT each and control around 45-50% of the global market. Domestically, there are only two players in the Graphite Electrodes Industry - GIL and HEG. Both the players have recently completed their expansion projects post which, the combined capacity in India has gone upto about 112000 tonnes. HEG has expanded its manufacturing capacity to 52,000 MT in comparison to GIL's capacity of 60,000 MT in India. Consequent to its capacity additions, GIL has emerged as the key player in the Graphite Electrode business for South East Asia. Entry Barriers:

We believe that the two major entry barriers for any new entrant in the industry are the high capital cost of setting up an electrode plant and the technology involved. The average cost of setting up a Graphite Electrode Plant is about $ 10,000 per tonne and the minimum viable capacity is about 30,000 TPA. This is an effective entry barrier for relatively smaller players. The technology for manufacturing Graphite Electrodes is also closely guarded. GIL obtained the technology from SIGRI Corp., which has since merged to form SGL Carbon. Prices have an upward bias: In FY03, the price of Graphite Electrodes had fallen to low of about $1,600 per tonne from about $3,000 per tonne prevailing earlier. In addition to the slight softness in demand, the prices had to be lowered by the major players to accommodate the penalties imposed on them in the cartelization case. In late 1990s, Steel producers in US and Europe filed complaints against Graphite Electrode producers like SGL Carbon and GrafTech against cartelization and manipulation of prices. The American and European Graphite Electrode producers lost the lawsuit in 1999 and had to shell out huge penalties of about $700mn over a period of time. These developments led to large-scale restructuring in the industry. Some of the leading western manufacturers either totally closed down their high cost operations or have moved them to lower cost locations. During FY03, a couple of high cost small-to-medium players in USA and Germany ceased operations due to the economic slowdown during that fiscal. However, since then, prices have tended upwards in sympathy with the increase in demand and contraction of capacities. A part of the price increase is also attributable to the increase in the cost of the main R/M viz. Petroleum Coke. Prices are currently ruling at an average of $3200 per tonne with booking for the next calendar being done at even higher prices. Of late, Graftech and SGL have announced spot prices of more than $4,000 per tonne. With an expected high growth in demand over the near future, we believe that prices will maintain their upward bias. Financial Performance: GIL had issued FCCB for USD 40mn. in October 19, 2005, to finance its expansion plans. Bonds are to be converted at Rs. 57/- per share within 5 years. We have assumed full conversion to happen in FY08 and accordingly, increased the Equity.

Total Income PBIDT Interest Depreciation PAT Equity

YEAR 31.3.2005 (crs.)

ENDED 31.3.2006 (crs.)

593.95 112.58 11.82 24.66 60.43 29.38

805.83 150.60 23.38 32.10 68.35 29.38

Future Prospects: 2006-07E (crs.)

2007-08E (crs.)

Total Income PAT Equity (Rs. 2 F.V.) EPS

1075.00 109.00 29.38 7.42

1410.00 155.00 35.60 8.70

Company has undertaken capex of Rs. 55 crs. to increase its baking/re-baking capacity at its Nasik Plant. This expansion will enable company to run its German Plant at full capacity. It is also incurring capex of Rs. 24 crs. at its German Unit to meet environmental norms and for implementing ERP. Company is also spending Rs. 4 crs. to increase capacity of its IGE Division. Company is also expanding capacity of its GRP/FRP Pipes Division. Valuations: Stock is trading at 6.73 x FY07E EPS and 5.75 x FY08E EPS. Several big funds FII like Citigroup, Prudential, HDFC, DSP ML, Principal etc. are holding large chunk of its Equity. Stock is highly undervalued considering the following: 1)

It has emerged as fourth largest producer of Graphite Electrodes in the world.

2)

High Entry Barrier.

3)

Company has already covered its R/M requirements for 07-08.

4) Company has already sold out its production at USD 3800 - 3900 for 07-08 as against USD 3200 in current year. At CMP, scrip is a Value Buy with almost negligible risk. If, stock has modest P.E. Ratio of 12, it shareprice should be Rs. 105/- based upon next year's earnings. Stock is lying low as some investors expressed their fear about rise in R/M prices. However, rise in R/M cost is being easily passed on to its customers due to aggressive demand scenario and hence, company is able to increase its profits. Our price target as under: 1)

Rs. 75-78 by Nov. 07.

2)

Rs. 105/- by July 08.

A Must Buy for every investor. Report written by: Hemant K. Gupta Centre for Development of Financial Treasure 212, Ravi Industrial Estate Off Mahakali Road Andheri (East) Mumbai-93. Tel. No: 022-26873540. Email ID: [email protected] Important Disclaimer: Hemant K Gupta is an independent publisher of stock reports. The research report is submitted to www.equitybulls.com by Mr. Hemant K Gupta to publish in the free platform

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