Goa Carbon Q1: Weaker end market demand, lower product spreads key negatives

Production volumes are breathing again, thanks to the lifting of the ban on key raw materials. But below-par capacity utilization remains a work in progress

The sequential improvement in sales volume through utilization is still sub-par

Operating profit impacted by adverse operating leverage and lower spreads

While volumes are expected to gradually improve, margins would stabilize at low teens

Key positive - GPC import quota fairly covers requirement in FY20

Goa Carbon, the second-largest manufacturer of CPC (calcined petroleum coke) in India, posted another weak quarter, mainly due to weakness in end markets, partially offset by improving capacity utilization and signs of moderation in raw material cost.

Sequentially, there was an improvement because of higher production volumes. Sales grew by 7 percent QoQ (quarter on quarter) and 11 percent YoY (year on year).

To provide a perspective, higher production volume was possible as the Supreme Court had lifted a ban on key raw material – green pet coke (GPC). In Q2 and Q3 of FY19, the company was adversely impacted by the SC ban on pet coke. However, sequentially, sales volume has picked up from Q4.

Furthermore, it’s noteworthy that since the GPC import allowed for the company in FY20 is 3,30,000 tonnes, it roughly covers its requirement of ~90 percent plant utilization, factoring in EPCA’s (Environment Pollution Control Authority) calculations.

Please read: Rain Industries: Adverse SC action has a material impact on the business model

Having said that, the capacity utilization level of 76 percent is still sub-par. The company updated that key plants (Goa and Bilaspur) were shut down for a substantial period owing to lack of viable export and domestic orders.

Source: Moneycontrol Research, EPCA

Second, the raw material cost has moderated compared to the previous quarter, leading to gross margins improving to 11.3 percent as against 5.4 percent in Q4 FY19. However, compared to the previous year, gross margins are way behind, which are impacted by both higher raw material cost (+31 percent YoY) and weaker CPC prices.

Key negative

Operating profit was negative this quarter on account of prevailing negative operating leverage and uninspiring gross margins. The firm continues to be impacted by adverse operating leverage as the utilization rate is sub-par due to lower offtake.

Key observation

In recent times, there has been commissioning of new CPC plants in China, leading to the adverse supply-demand situation. Domestic smelters have been procuring CPC from China because of discounted prices, which has led to lower offtake.

Outlook

We acknowledge that key headwind for the company in terms of availability of imported GPC is taken care of, post implementation of import quota. Also, we expect a gradual recovery in the domestic market as the end clients (aluminum smelters) exhaust their import quota restriction of CPC, which is 500,000 tonnes. The CPC import quota allowed for smelters covers only 30 percent of their annual requirements and hence, they are expected to come back later to domestic players such as Rain Industries and Goa Carbon for their requirements.

Having said that, the weaker end market (aluminum) can lead to domestic production moderation at the smelter's end. This implies that capacity utilization for Goa Carbon can remain lower for longer.

On account of the weak trends for CPC prices and the lower spread between GPC and CPC prices, we expect EBITDA margins to stabilize at low teens in the medium term. As far as the stock is concerned, it has corrected by 63 percent from its 52-week high and trades at 7.7x FY20e earnings. While a large part of headwinds is already in the price, concerns on the profitability are visible and hence, we remain on the sidelines.

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