Steel is a cyclical sector in nature. Demands for steel arise are interlinked with a nation’s economic progression & infrastructure development.
When a country develops its infrastructure it builds new bridges, tunnels, roads, railways lines, metro, etc. All these above activities heavily consume the steel.
Leave the country for the moment. When you buy a new car, washing machine, refrigerator, or build a new house your consumption of steel as individual increases.
So, when an economic turnaround happens, demand for steel increases, and this demand raises the steel price uptrend.
In the same way, when a country’s economy does poorly and capital expenditure for infra projects comes to a halt & demand for steel goes down & so does the price of the metal.
Manufacturing:
Steel is primarily manufactured through two major processes:
- Blast furnace root
- electric arc furnace. (EAF)
In the blast furnace method, iron ore/ coal is used as a raw material
In the EAF method steel is manufactured by using graphite. To produce a ton of steel 2 to 3 kg of graphite is consumed as a raw material.
Also, Graphite electrodes can withstand high temperatures. More than 2000 degrees Celsius comes into the picture to produce steel.
As every nation across the globe fights against global warming due to carbon emissions. Steel manufacturing is a high carbon emission industry. Where EAF methods emit 1/4th of carbon compared to the blast furnace method.
EAF offers a low production cost of steel compared to the Blast furnace.
At this moment, 53 % of the globe (excluding China) adopts the EAF method to manufacture their steel.
As of 2021, the overall production of steel is 1864 MT across the globe. In that 1037 MT steel comes from China. Yes, you read it right! China accounts for more than 55 % of steel production.
But the catch is that 95 percent of their steel is produced through the blast furnace method. So the steel sector contributes 15 % of the carbon emission in their overall carbon emission.
Also, the inefficient blast furnace must shut down, thus it reduces exports of Steel.
Due to air pollution, China is aiming to convert 20 percent of its steel manufacturing through the EAF method. For this, you need graphite as a raw material.
Again, China is the leading manufacturer of graphite electrodes. 62 percent of graphite comes from China on a global level. What a strategic advantage China possesses. So enviable. Isn’t it?
Graphite requires needle coke as raw material. China is using this needle coke and graphite in the batteries of the EV sector.
In 2021, China has 3.3 million new energy passenger vehicles which accounts for 53 percent of global EV sales. (source: https://thedriven.io/)
Every car carries about 50 to 60 kg of graphite. Due to the huge size EV market, new entrants to EAF (Electric arc furnace) plant demand for graphite is going to shoot up in the near term.
Read more about: How to be debt free in 2022?
Why are Steel and Graphite sectors married?
Steel sector due to its cyclical nature, also large dependence on infrastructure projects, the economic revival, etc. The demand and supply of graphite are heavily based on the steel sector. Since 50 percent of steel manufacturers adopt the EAF method.
The balance sheet of steel companies and graphite companies look similar.
From the below chart, you can see steel prices are going down from 2012 to 2016.
Source: https://tradingeconomics.com/commodity/steel
And the similar pattern of profit and sales downtrend is shown in the HEG balance sheet. HEG is one of the leading Indian graphite electrode manufacturers.
Source: https://www.screener.in/company/HEG/consolidated/
Risk involved:
I would say not only the steel sector is cyclical even the Graphite sector too.
Graphite prices are exposed to steel demand and supply. In the last bear cycle of steel, the prices of graphite touch a rock bottom of 2000 USD / tonnage.
From 2007 to 2018, the average graphite price stood at 3700 USD / per ton. Post COVID combined with global economic recovery steel demand is increasing and graphite prices are hovering at 5300 USD to 5500 USD per ton.
The industry itself is capital intensive. There were 200000 TPA collectively shut down in the western countries during the last bear cycle of steel.
Unless a firm has high liquidity it’s hard to run the show in hard times.
Even the Graphite price is subjected to cyclical. Needle coke is a raw material used for Graphite manufacturing which is a crude derivative.
Opportunities:
Due to the fight against global warming, EAF steel manufacturing is going to thrive since every country wants to reduce its dependency on blast furnaces.
Research agencies are projecting a growth of 5 percent CAGR for the next 6 to 8 years.
Whenever an economic downturn comes its way, consider it a blessing in disguise. Because of the downturn capital intensive projects comes to a halt, unimpressive quarter number of steel and graphite stocks allows entering.
The longer the downtrend continues, the lower the demand for steel & which is reflected in shares of steel companies & graphite manufacturers.
Having a close look at China helps a lot in this sector. Trends like cutting down export, low production of steel, and policy changes in China soar the steel prices globally.
I believe If one can hold a steel stock for 3 to 5 years during times of recession, unfavourable economic conditions will be surely rewarded.
Mind you, both steel and graphite shares rise and fall simultaneously.
Top players:
Let us look at the big guys in the Graphite industry & geography location.
45 percent of Graphite comes from the major five players.
GrafTech International:
It is based in Cleveland, Ohio, USA. Its annual production capacity of graphite stands at 230,000 MT. GrafTech operates in this industry for more than a century.
GrafTech plants are located in France, Spain, Mexico, Philadelphia, etc. GrafTech acquired Seadrift a leading producer of needle coke. Also, GrafTech believes the Seadrift is one of the largest producers of needle coke in the world.
Since GrafTech is integrated with raw materials, it does not affect the price fluctuations of needle coke. It offers a strategic advantage to GrafTech compared to its competitors where raw material needle coke is sourced from suppliers.
GrafTech accounts for 25 percent of graphite electrode manufacturing across the globe (excluding China).
Showa Denko Carbon:
Showa Denko carbon division is a subsidiary of Showa Denko Group. It’s the world’s largest supplier of ultra-high powered graphite electrodes (32-inch diameter).
Its production capacity of graphite stands at 210,000 MT. They are in the industry for more than 100 years catering to high-quality graphite electrodes to electric arc steelmakers worldwide.
Graphite India:
Graphite India is based in Durgapur, West Bengal. It has 3 plants whereas 2 in West Bengal and 1 in Nashik.
It is the 3rd largest graphite manufacturer in the world accounts for 14 percent of graphite among the leading firms.
Graphite India has a capacity of 98,000 Mt and 37 percent of sales come from Exports. Due to geographical advantage, friendly manpower cost, and high liquidity the firm managed to withstand wherein Graphite prices were down.
Tokai Carbon:
Tokai Carbon is another Japanese major in Graphite electrode manufacture. It’s headquartered in Tokyo, Japan. Its production plant spread across Japan, Germany, and America.
Tokai Carbon’s production capacity stands at 96,000 MT. It is also the manufacturer of large diameter ultra-high-powered electrodes.
HEG:
HEG is based in Noida, India. It is one of the world’s largest single integrated graphite manufacturers under one roof.
Its production stood at 80,000 MT per annum, and it is working on expanding its capacity to another 20,000 MT. This expansion work will be fully functional from the end of 2022.
So it can emerge as the third-largest graphite producer and leader in India.
It has high liquidity to handle adverse conditions and low operational costs due to manpower, and geographical advantage.
Conclusion:
An investor with the courage to take risk and convictions in their own research work & belief can definitely take positions in steel and Graphite companies which has their debt in NIL and high liquidity.
Also one should be comfortable leaving the money for 3 to 4 years till the economy revives (It won’t take that long usually, the worst-case scenario considered).
The economic downturn offers opportunities for bold and well-informed investors. Thanks for reading!
Happy Investing!
This article is for educational purposes. Don’t take it as a piece of investment advice. Also, I am not an investment advisor nor associated with an investment firm. kindly do your own due diligence.
