By Vivek Jain

India Ratings and Research (Ind-Ra) has affirmed HEG Limited’s Long-Term Issuer Rating at ‘IND A’. The Outlook is Stable. The instrument-wise rating actions are as follows:

Instrument Type

Date of Issuance

Coupon Rate

Maturity Date

Size of Issue (million)

Rating/Outlook

Rating Action

Term loan

-

9.9%-10.05%

March 2022

INR2,347.0 (reduced from INR2,371.2)

IND A/Stable

Affirmed

Commercial paper

-

-

30-210 days

INR1,000

IND A1

Affirmed

Fund-based working capital limits

-

-

-

INR5,050 (reduced INR6,550)

IND A/Stable/IND A1

Affirmed

Non-fund-based working capital limits

-

-

-

INR1,950 (reduced from INR2,600)

IND A/Stable/IND A1

Affirmed

KEY RATING DRIVERS

Industry Scenario Turns Favourable: The affirmation reflects consolidation in the graphite electrode industry with the merger of Showa Denko K.K. and SGL Carbon SE to create the world’s largest graphite electrode manufacturing company, with a capacity of 260,000tpa. Additionally, Brookfield Asset Management took over Graf-tech International Limited (160,000tpa), thus 60% of the global 697,000tpa of ultra-high powered graphite electrode capacity is concentrated in the hands of two players. Also,  steel manufacturing though the electric arc furnace route has again turned favourable compared to the blast furnace route, given the global fall in scrap prices and the rise in the iron ore and coking coal prices, thus increasing the demand for graphite electrodes which are used in the electric arc furnace route, Lastly, China has closed down 25-30 million tonnes of polluting steel manufacturing capacity and graphite electrode capacity, resulting in a shortage of graphite electrodes even in the country.   

Graphite Electrode Prices Rise:
With the tightness on the supply side, given the change in the industry structure and demand remaining healthy, the demand-supply balance has shifted in the favour of the suppliers. This has resulted in a significant increase in graphite electrode prices to nearly USD4,000/t from USD2,000/t in the spot market. However, most players have not been able to take the full benefit of the price increase, given that the graphite electrode industry contracts for 60%-70% of the capacity at the beginning of a calendar year. The benefit of the increased prices will largely be realised in 2HFY18, given that capacities in these quarters would have been contracted at higher prices. 

Liquidity Remains Comfortable:
HEG has term loan repayments of INR1.4 billion in FY18, which it will meet through fresh borrowings and operational cash flows. Post the additional term loan, Ind-Ra expects HEG’s repayment profile to be comfortable at INR380 million and INR664 million in FY19 and FY20, respectively, thus resulting in comfortable DSCR of 1.9x and 1.7x. Given the improvement in EBITDA and lower incremental borrowings, Ind-Ra expects HEG’s interest coverage to increase to about 2.5x in FY18 (FY17: 1.5x, FY16: 2.3x). HEG also has fund-based limits of INR5.05 billion which on average were utilised 83% over the 12 months ended March 2017. Moreover on the export packing credit, the company has an interest subvention of 3% till FY21, thus lowering the effective rate of interest. On a blended basis, the company pays 7.75%-8% on its working capital loans. 

Leverage to Remain High in FY18, Despite Improvement:
Ind-Ra expects HEG’s leverage to remain high in FY18, despite the likelihood of an improvement below 4.0x (FY17: 8.4x) on a strong improvement in EBITDA, a stable working capital cycle (FY17: 226 days) and repayment of part of the term loans from cash flows. Ind-Ra further expects HEG’s capacity utilisation rates to improve to 75%-80% in FY18 (FY17: 62%, FY16: 57%) and result in positive rub-off of operating leverage. The EBITDA at INR0.8 billion in FY17 (FY16: INR1.4 billion) was significantly lower than Ind-Ra’s expectation of INR1.2 billion, on account of the higher-than-expected fall in the graphite electrode prices. During FY17, the company reduced its borrowings by INR1 billion to INR6.8 billion using healthy free cash flows of INR1 billion (FY16: INR1.5 billion).

Needle Coke Prices Also Rise:
The prices of needle coke have also increased 50%-60% yoy. Though the prices are set annually, this time around they were set on a half yearly basis which exposes the company to the risk of a price hike in 2HFY18 while the pricing of electrodes has been almost frozen for the full year. The impact on the profitability, however, would be limited, as the manufacturing cycle of the company is three to four months, thus the prices which would be reflected in FY18 operations would be lower as needle coke would have been procured during 2QFY18 and early 3QFY18. 

Capex Likely as Capacity Utilisation Improves
: The industry might also look at fresh capex, as capacity utilisations reach 80%-85% in FY19. HEG could also look at fresh capex in FY19 at the existing plant location to increase the capacity to nearly 1,00,000tpa (FY17: 80,000tpa). This though remains contingent on the company achieving higher capacity utilisation rate, the same if done, would result in a higher leverage ratio. 


RATING SENSITIVITIES

Positive: A significant improvement in the capacity utilisation levels, EBITDA and working capital cycle leading to lowering of net financial leverage below 3.5x on a sustained basis would be positive for the ratings. 

Negative: Deterioration in the capacity utilisation levels, a further decline in EBITDA a stretch in the working capital cycle and/or debt-led capex resulting in net leverage sustaining above 5x would be negative for the ratings.



COMPANY PROFILE

HEG, set up in 1977, is a flagship company of the LNJ Bhilwara Group. It manufactures graphite electrodes at its 80,000tpa facility in Madhya Pradesh. HEG reported revenue of INR8.96 billion in FY17 (FY16: INR9 billion) and a net loss of INR493 million in FY17 (net loss INR78 million). 


RATING HISTORY

Instrument Type

Current Rating/Rating Watch

Historical Rating/Outlook

Rating Type

Rated Limits (million)

Rating/Outlook

16 November 2016

2 November 2015

27 March 2014

Issuer rating

Long term

-

IND A/Stable

IND A/Stable

IND A+/Stable

IND A+/Stable

Term loans

Long term

INR2,347.0

IND A/Stable

IND A/Stable

IND A+/Stable

IND A+

Fund-based working capital limits

Long term/Short term

INR5,050

IND A/Stable/IND A1

IND A/Stable/IND A1

IND A+/Stable/IND A1+

IND A+/IND A1+

Non-fund-based working capital limits

Long term/Short term

INR1,950

IND A/Stable/IND A1

IND A/Stable/IND A1

IND A+/Stable/IND A1+

IND A+/IND A1+

Commercial paper

Short term

INR1,000

IND A1

IND A1

IND A1+

-


COMPLEXITY LEVEL OF INSTRUMENTS

For details on the complexity level of the instruments, please visit https://www.indiaratings.co.in/complexity-indicators.

SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings. 

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

ABOUT INDIA RATINGS AND RESEARCH

India Ratings and Research (Ind-Ra) is India's most respected credit rating agency committed to providing India's credit markets accurate, timely and prospective credit opinions. Built on a foundation of independent thinking, rigorous analytics, and an open and balanced approach towards credit research, Ind-Ra has grown rapidly during the past decade, gaining significant market presence in India's fixed income market. 

Ind-Ra currently maintains coverage of corporate issuers, financial institutions (including banks and insurance companies), finance and leasing companies, managed funds, urban local bodies, structured finance and project finance companies. 

Headquartered in Mumbai, Ind-Ra has six branch offices located in Ahmedabad, Bengaluru, Chennai, Delhi, Hyderabad and Kolkata. Ind-Ra is recognised by the Securities and Exchange Board of India, the Reserve Bank of India and National Housing Bank. 

India Ratings is a 100% owned subsidiary of the Fitch Group.

For more information, visit www.indiaratings.co.in.

DISCLAIMER

ALL CREDIT RATINGS ASSIGNED BY INDIA RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.INDIARATINGS.CO.IN/RATING-DEFINITIONS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.INDIARATINGS.CO.IN. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. INDIA RATINGS’ CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE.

Applicable Criteria

Analyst Names

  • Primary Analyst

    Vivek Jain

    Director
    India Ratings and Research Pvt Ltd 601-9 Prakashdeep Building 7 Tolstoy Marg New Delhi 110001
    +91 11 43567249

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121