heg ltd Management discussions

THE ECONOMIC OVERVIEW

World Economy: The global economy demonstrated exemplary resilience reporting a GDP growth of 3.4% (reported by IMF) despite extreme volatility and uncertainty across the World.

The global fight against inflation, Russia/Ukraine war, a resurgence of COVID-19 in China, and recessionary headwinds prevailing in the US and Europe in the first half of 2022 altogether a_ected global economic activity detrimentally.

The surprisingly strong trend reversal in the global economy in the third quarter of 2022 played a decisive role in rebounding the global economy. The sources of these surprises were, in many cases, domestic: stronger-than-expected private consumption and investment, and greater-than-anticipated fiscal support. Households spent more. Business investments increased.

On the supply side, easing bottlenecks and declining transportation costs reduced pressures on input prices and enabled a rebound in previously constrained sectors; energy markets adjusted faster than expected to the shock from RussiaRs.s invasion of Ukraine.

Commodity prices remained volatile throughout the year. Despite the instability, global trade in goods remained high owing to a strong rebound in household consumption.

Outlook: Russia/Ukraine war overshadows the world economy. Despite recent signs of improvement, recovery over the next two years is expected only to be moderate. The outlook remains fragile, and downside risks predominate. Trade tensions are high and could further worsen. Concerns about financial vulnerabilities have risen, including in financial institutions, housing markets, and low-income countries. While headline inflation has started declining, it remains elevated and could persist longer.

Emerging economies are likely to perform better in CY23 compared to their advanced counterparts. New trade agreements are anticipated to fuel global trade in 2023. And the overall shift manufacturing trends would be shifting towards green energy, investment in digital tools, and better integration with suppliers.

2022 saw the global economy surpass US$100 trillion for the first time, reaching US$101.6 trillion. According to the source, the top five countries account for 51% of global GDP. In the same year, India overtook the United Kingdom to become the worldRs.s fifth-largest economy.

Indian Economy: In the financial year 2022-23, in the aftermath of Covid, India stood out as one of the finest examples of hope and optimism while the world was tipping toward recession. After a spectacular rebound in FY22 from a lower base, the Indian economy again registered a healthy 7.2% growth in the GDP. Growth was underpinned by investment activity led by the GovernmentRs.s strong capital expenditure thrust, subsequent capital formation, and return on private consumption. However, inflation remained high all year-round year round.

Inflation: CPI (Consumer Price Index), which measures the retail inflation of goods and services across 260 commodities, hit the highest 7.79% in April 2022. Subsequent monetary policy tightening by the RBI throughout the financial year comforted/assured consumers. By the end of March 2023, the headline inflation declined to 5.66%, within RBIRs.s upper ceiling.

Exports & the rupee: Overall exports (merchandise and service) were US$ 770.18 billion worth during FY23 growing at 13.84% over the previous financial year. Supported by the gains from high services exports, the moderation in oil prices, and the recent fall in import-intensive consumption demand, IndiaRs.s current account deficit is estimated to fall in FY23 and FY24, providing a bu_er to the rupee in uncertain times. This will provide a much-needed cushion to IndiaRs.s external sector at a time when the Fed is likely to raise rates further.

Manufacturing: IIP data shows manufacturing and electricity witnessed strong traction in the first 11 months of FY23, registering an overall growth of 5.5%. In that same period, mining, manufacturing, and electricity, three principal components of the IIP, grew by 5.7%, 4.9%, and 10.0%, respectively. Despite elevated input prices, new investments announced in the manufacturing sector during April-December 2022 were five times that of FY20.

Outlook: India will remain one of the fastest-growing major economies, notwithstanding the growth slowdown in advanced economies. Despite sluggish exports, industrial output should remain healthy due to robust domestic demand. GDP estimates for FY24 by international and Government agencies are between 6-6.5%.

THE

STEEL SECTOR

World Steel: Global crude steel production fell for the first time in seven years in 2022 on the back of ChinaRs.s strict zero-COVID policy and issues in the real estate sector. Other factors leading to the drop in steel production were the Russia/ Ukraine war, and soaring energy prices leading to widespread plant idling, and production stoppages, especially in Europe.

Demand: A dismal economic landscape, elevated inflation, and supply chain bottlenecks forced a reduction in steel demand worldwide which was more pronounced in all advanced economies. As a result, the Global Steel demand contracted by an estimated 3.2% in 2022. Economic issues and a resurgence of Covid-19 in China impacted steel demand in the nation - it contracted by about 3.5 % in 2022.

Production: According to the World Steel Association, global crude steel output slipped in 2022 to 1,885.4 mmt down 4% from the previous year. While capacity utilisation declined significantly in 2022, global steelmaking capacity is expected to increase in the same year. Among the top 10 crude steel-producing countries, India and Iran were the only nations to register positive growth in steel production in 2022.

Prices: Steel prices also went through a long-term decline in 2022. After a healthy rise in the first quarter of the year, steel prices dipped every month, resulting in a volatile demand-supply equation. Factors such as ChinaRs.s COVID control e_orts, slowing down of UkraineRs.s production due to war, and sanctions against Russian goods, and the subsequent global downturn impacted steel prices during the year.

Outlook: Worldsteel forecasts a revival in the steel sector in 2023 as demand will see a 2.3% rebound to reach 1,822.3 mmt. The improved demand estimate is owing to high infrastructure demand in major economies. For instance, in the US, the new infrastructure law is expected to boost the sectorRs.s investment despite the depressing economic environment.

Global steel demand will also be supported by the healthy uptick predicted in the automobile industry. After a strong showing in 2022, automobile production will continue to witness robust growth in 2023 due to improvements in the availability of semiconductors.

India Steel: The steel industry is the backbone of the industrial sector and the Indian economy. In FY22, India became 2nd largest consumer of finished steel.

The financial year 2022-23 was a di_cult one for steel companies with a slew of headwinds, such as the government imposing an export duty on the metal, and elevated input costs. While the export duty levy was rolled back in November, the weak global demand environment did not help elevate the industryRs.s fortunes.

IndiaRs.s crude steel production rose by 4.18% to 125.32 mmt in FY23 against 120.29 mmt in the previous fiscal. The finished steel production was 121.29 mmt, up 6.77% from 113.60 mmt a year ago.

Domestic steel consumption rose by 12.69% to 119.17 mmt against 105.75 mmt in 2021-22. This jump is attributed to increasing infrastructure activities across the nation.

IndiaRs.s steel exports slumped to one of their lowest since FY19, with the country exporting only 6.72 mmt in FY23, halving on a year-on-year basis, according to the provisional data from the Steel Ministry. The fall comes on the back of an export duty imposed for six months of the fiscal and weakening demand in key markets due to economic and geopolitical headwinds.

Imports surged about 29% to 6.02 mmt in FY23 from 4.67 mmt in FY22. The saving grace was that India continued to retain its position as a net exporter of finished steel for the fiscal gone by, with exports exceeding imports by 0.7 mmt. Outlook: The prospects for the domestic steel sector appear promising in the short- and long-term horizons.

Short-term outlook: Despite the prevailing geopolitical turmoil and financial instability, the Indian economy is firmly placed on a growth track underpinned by strong urban consumption and infrastructure spending by the Government.

The recent Union Budget has sharpened the GovernmentRs.s focus on infrastructure creation with the highest-ever allocation to infrastructure development across the nation. This is expected to spur the demand and consumption of steel significantly over the next couple of years.

Also, the private sectorRs.s capacity augmentation plans should support the growth of the steel sector.

Additionally, the strong uptick in the real estate (residential and commercial), automotive, and consumer goods sectors will add to steel demand.

Long-term potential: As per a recent estimate, the WorldRs.s per capita steel consumption stands at 233 kg, whereas a person in India consumes, on average, only about 77.2 kg. A slight uptick in IndiaRs.s per capita consumption creates an enormous opportunity for steel producers in India. According to the National Steel Policy, 2017, the Government has targeted a 160 kg per person consumption by 2030-31, where government schemes like Atmanirbhar Bharat, Make in India, PMGatiShakti Plan, PMAY, multiple PLI schemes, etc. will provide impetus to the sustained growth of the steel sector.

THE EAF STEEL SECTOR

After holding between 25 – 28 % of global steelmaking production for about a decade through 2012, the migration to electric arc furnace (EAF) steelmaking accelerated during the past decade. This has been primarily fuelled by adopting the EAF route as the preferred steelmaking route for reducing the carbon footprint of the steel sector. According to the World Steel Association, the share of steel manufactured through the electric arc furnace route in the world (excluding China) has increased from 44% in 2015 to 50% in 2022.

The electric-arc route for steelmaking uses high-current electric arcs to melt steel scrap and convert it into liquid steel. The primary charge material for EAF is scrap steel, and its quality and availability at low cost are essential.

EAF plants are less expensive than traditional integrated steelmaking plants. It is also very cost-e_ective in terms of low production rates. Another significant advantage of EAF is its improved e_ciency over blast furnaces. The EAF is also a self-contained system that operates on a much smaller footprint that does not require a secondary heating source.

New-age steel industries are adopting EAF technology due to the growing demand for recycling and reducing greenhouse gas emissions. Therefore, increasing the share of EAF-based steel production will play a key role in decarbonising the steel industry.

Key to carbon neutrality:

Over the next decade, EAF steelmaking production will be a big winner in the race to produce "green," "carbon neutral" steel.

The US: EAF-based steelmaking production in the U.S. accounts for about 70% of the total steel production. But the nation faces the challenge of identifying appropriate feedstock for its EAF units.

Europe: European steel producers have worked diligently over the past two decades to reduce the carbon footprint of the steel produced through traditional integrated steelmaking, having accomplished the lowest levels possible from a scientific perspective. The only path available to them to further reduce their carbon emissions is to shift to EAF production using alternative metallics, and divert significant capital investments that would have been used to sustain their blast furnace/ basic oxygen furnace (BF/BOF) production with EAFs.

China: No discussion about global steel is complete without a discussion on China, owing to its unquestioned dominance in the sector. It produces about 50% of the global steel production.

China has been late in adopting the EAF route. A little more than 10% of its steel is produced through this route. According to the Ministry of Industry & Information Technology, crude steel produced via electric-arc furnaces will exceed 15% by 2025 and 20% by 2030 to aid ChinaRs.s goal of de-carbonising the steel industry.

Realising the challenge of the US and Europe in securing sustained supplies of scrap for their large and growing EAF capacities, China is proactively working on building its scrap reservoir.

The countryRs.s industrial production started in earnest in 2003. Steel has a useful life ranging from 25 to 40 years, indicating that ChinaRs.s scrap reservoir will begin to build in earnest over the next decade. It is believed that the Government will take steps to keep that scrap at home, somewhat similar to what the Russians are currently doing.

With scrap becoming increasingly available at home and a cost-competitive price compared with o_shore-sourced iron ore and coal, ChinaRs.s EAF-based steelmaking will further strengthen its competitive edge in the global steel world.

Other regions: Asia Pacific is expected to be the largest market for EAF plants, with the highest growth rate in the coming years owing to increased investments in capacity expansion. Similarly, the Middle East, Africa, and Latin America are some of the hotspots for the growth of the EAF industry. Here, the presence of capital-intensive companies, low cost of labor and rapid industrial developments in the last few years hold the key.

THE GRAPHITE ELECTRODE SECTOR

Graphite electrodes (GE) are manufactured using premium petroleum needle coke, coal tar pitch, and some additives. It finds its applications in steel manufacturing and other non-ferrous metals through the EAF and the ladle furnace routes. Graphite is the only material that can withstand extremely high temperatures while transmitting electrical power to create the arc. Hence, the EAF steel route is graphite electrodesRs. most significant consumer and business driver.

FY23 has been a challenge for the graphite electrode sector owing to the muted performance of the steel industry, especially Europe (where the EAF route comprises a notable proportion of the steelmaking capacity).

The surge in energy prices across Europe, owing to the Russia - Ukraine war further dented the performance of graphite electrode players operating in Europe.

With the steel sector expected to rebound globally, the prospects for the graphite electrode industry appear promising.

Further, the long-term demand for graphite electrodes appears to be healthy, with almost all the steel-producing nations endeavoring towards carbon neutrality and gradually shifting towards the EAF route for steel making. business driver.

SWOT Analysis

Strengths	Weaknesses
Established technology that is closely guarded.	The industryRs.s fortunes are closely linked
The uncluttered industry with select players of a global scale.	to steel demand.
No new capacity has been announced for graphite electrodes in the western world.
Opportunities	Threats
Decarbonisation measures in the steel sector will increase the share of EAF-based steel production and respective demand for graphite electrodes.	Diverting key inputs for other products like EV batteries which are high in demand globally.

BUSINESS PERFORMANCE

Graphite Electrodes

Economic and sectoral volatility impacted business operations during FY23. Our capacity utilisation for the year was 89% as against 90% in the previous year but our sales volumes were muted due to global conditions and slowdown of steel production.

While the marketing team focused on securing business volumes despite the multiple headwinds prevailing across the globe, the operations team continued its e_orts towards sustaining world-class quality of its output and optimising operating costs.

Most of the processes of the expansion project were set up and trials were successfully done. The Company expects to commence commercial production in the second quarter of FY24. The additional capacity would allow the Company to capitalise on emerging growth opportunities e_ectively.

Power Generation

The Company has a 76.5 mw captive power generating capacity comprising of thermal and hydel power generating assets. The thermal plants remained closed throughout the year due to high coal prices making operations unviable.

However, our hydel plant continued to operate as per plan with a record generation of 7.74 crore units with revenue of C47.10 crore.

QUALITY MANAGEMENT

At HEG, Quality Management is not an operational function but an organisational culture steadily woven into the organisationRs.s fabric over the year.

Quality is everyoneRs.s job, from the top floor to the shop floor. At the shopfloor: Institutionalised SOPs and stringent adherence to global standards is the hallmark of HEGRs.s manufacturing unit. Quality is looked upon from both process and product perspectives. Maintaining process quality is a precursor to quality output and helps minimise wastage. In addition, rigorous checks are conducted on the output (across the process and the final product) to ensure that it matches customer requirements. A stringent quality control protocol also applies to the raw materials we use. Continuous quality training across hierarchies helps in embedding the quality culture.

At the top floor: Business process automation across the organisation ensures speed and e_cient customer service (internal and external) while minimising human errors. Prudent checks and balances across the organisationRs.s hierarchy helps to raise the process quality. The senior management team and the marketing team continuously interact with key customers at regular intervals. Their feedback on the experience with HEG gets evaluated and absorbed into business processes.

The fallout of the passion for quality is that HEG services the top 25 steel-producing giants worldwide.

INNOVATION

Led by some of the best scientists in their field, HEGRs.s R&D center works tirelessly to improve existing processes and product quality.

They also work on identifying and working on new processes that could make business operations more e_cient.

The dedicated team also looks to develop newer carbon materials for energy, thermal and environmental management. They also try to explore new possibilities that could complement the business to boost growth and margin. The R&D team also works with well-known research institutions to find new sustainable ways for future growth.

HUMAN RESOURCE

HEGRs.s talent pool is the vital driving force behind its stellar performance over the years, customer commitment, and global reputation.

For the Company, peopleRs.s well-being is an important priority which gained considerable prominence during the pandemic days. It is reflected in the path-breaking measures adopted by the Company for its people.

With business back to normal, the Company continues to invest in people growth. The HR team focuses on continuous upskilling of the team on the technical, commercial and behavioral aspects. It also engages team members to participate in team-bonding exercises that reinforce the cohesiveness of the team.

The Company celebrated National events and some festivals to enhance team bonding beyond work. The IT department developed applications from time to time that enhanced transparency in the organisation while improving better connectivity with customers.

INTERNAL CONTROL AND ITS ADEQUACY

The Company has a sound system of internal controls to ensure the achievement of goals, evaluation of risks and reliable reporting of financial and operational information. This e_cient internal control procedure is driven by a robust system of checks and balances that ensures the safeguarding of assets, compliance with all regulatory norms, and procedural and systemic improvements periodically.

The Company uses an ERP (Enterprise Resource Planning) package supported by in-built controls. This guarantees timely financial reporting. The audit system periodically reviews the control mechanism as well as legal, regulatory and environmental compliances. The internal audit team also checks the e_ectiveness of internal controls and initiates necessary changes arising out of inadequacies, if any. The Audit Committee of the Board of Directors further reviews all financial and audit controls.

FINANCIAL PERFORMANCE

HEG reported an excellent performance in the face of a prevailing volatility. Despite a drop in sale volumes, the company reported superior all-round numbers.

The CompanyRs.s Revenue from Operations stood at C2,576 crore in FY23 against C2,281 crore in the previous year. Despite persistent inflation, EBITDA increased from C607 crore in FY22 to C729 crore in FY23. Net Profit for the year scaled from C391 crore in FY22 to C456 crore in FY23.

Net Cash Flow from Operations improved from C(141) crore in FY22 to C114 crore in FY23.

The improvement was despite the capital invested during the year in setting up its brownfield capacity. The commissioning of the new capacity should improve business liquidity going forward.

Net worth increased as business surplus (after paying dividend) was ploughed into the operations – it stood at C4,077 crore as on 31^st March, 2023 against C3,777 crore as on 31^st March, 2022. Return on Net worth stood at 11.60% in FY23 against 10.89% in FY22.

Significant changes (i.e., change of 25% or more as compared to the immediately previous financial year) in Key Financial Ratios, along with explanation are as under

Particulars	2022-23	2021-22	Change (%)	Reason
Operating Profit Margin (%)*	20.97	20.35	3%
Return on Net Worth (%)	11.60	10.89	7%
Net Profit Margin (%)	18.70	17.97	4%
Interest Coverage Ratio	24.09	70.45	-66%	Increase in average working capital utilisation, reduction in interest subvention scheme and increase in repo rate.
Current Ratio	2.16	2.34	-8%
Debt-Equity Ratio	0.18	0.18	3%
Debtors Turnover Ratio	4.52	4.95	-9%
Inventory Turnover Ratio	0.76	1.06	-29%	Subdued demand resulting in lower sales volume resulting in Increase in inventory.

* EBIT (before other Income) / revenue from operations.

Transaction of the Company with any person or entity belonging to the promoter/promoter group which hold(s) 10% or more shareholding in the Company is given below:

There was no transaction of the Company with any person or entity belonging to the promoter/promoter group which holds (s) 10% or more shareholding in the Company.

RISK

MANAGEMENT

HEG has put in place a structured Enterprise Risk Management framework (Rs.ERM frameworkRs.) based on the guiding principles of identifying, assessing and mitigating risk. It is an integral part of decision-making for HEG and is dynamic in nature, undergoing continuous improvement.

The ERM Framework follows an annual process of setting objectives, identifying key risks on an ongoing basis, developing a mitigation and action plan, and monitoring leading indicators and planning gaps.

Business growth risk

Business growth is essential to create shareholder value.

Mitigation measure

Business growth is closely dovetailed to the prospects of the steel industry, particularly the EAF steel sector. This steelmaking segment is expected to witness healthy growth over the medium term, given the sharpened focus on reducing the global carbon footprint.

Demand risk

Muted demand for the CompanyRs.s products could adversely impact its business growth.

Mitigation measure

The demand for graphite electrodes is expected to remain strong owing to increased demand from the user segment and reduced capacities for graphite electrodes (specific large capacities have been permanently shut in the recent past, and no new capacities other than the HEG on the anvil).

Funding risk

The Company would need adequate funds for its new capital project.

Mitigation measure

De-leveraged financial statements and adequate cash generation from business activities provide significant financial stability to the organisation to secure funds for implementing the project. Further, the increased cash flow consequent to the commissioning of the new graphite electrode capacity promises to strengthen organisational liquidity.

Talent risk

Loss of knowledge capital could impact business operations and performance.

Mitigation measure

HEG maintains an unwavering focus on fostering an energetic and encouraging work environment that motivates its people to up their performance. This has gone a long way in strengthening the employee bond with the corporate. HEG Invests in its people by training them in India and overseas and participating in various conferences and exhibitions to build the knowledge base of people. Each key employee is shown a clear growth path and their aspirations are matched with organisational objectives.