Buy proxy plays on steel stocks? No steam left post stellar returns, say market mavens

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Shares of graphite electrode makers — Graphite India and HEG — have generated staggering returns in the last one year as many investors took refuge in the sector considered as a proxy play to steel stocks. To put it into perspective, Graphite India share prices have zoomed over 250 percent in 1 year and 108 percent YTD, while HEG share prices have soared 200 percent in 1 year and 142 percent YTD.

Graphite electrode manufacturers have been witnessing a strong uptrend in demand with the gradual re-opening of the economy and expected pick up in construction activity and, in turn, the steel industry.

For uninitiated, Graphite electrodes are used as the main heating element in the electric arc furnace (EAF) method of making steel.

The major steel-consuming economies and industries are expected to gradually return to normalcy in the second half of FY22 which is seen driving demand and production for graphite electrode makers.

Besides, faster adoption of the EAF method by China — one of the world’s largest steel producers and consumers — will definitely act as a tailwind for graphite electrode makers, analysts said.

A few months back, several money managers had touted investing in proxy plays like Graphite India and HEG instead of betting on steel stocks.

Now that these shares have run up too much, several fund managers have trimmed their exposure in stocks like Graphite India and HEG and have taken some money off the table.

“One should be careful while investing in metals space, even proxy plays, at the current market price. In case one has missed out on the rally so far, it’s better to stay away for now given the unfavorable risk-reward. One could look at adding some in their portfolio post a reasonable correction,” said Ambrish Mishra, Head of Portfolio Management Services at IDBI Capital Markets.

Fundamental Outlook

Priyam Shah, Investment Analyst at a wealth management firm that caters to HNIs:

Graphite India and HEG were good proxy plays until a few months back, but now the risk-reward ratio does not justify a fresh entry. Metal stocks, specifically steel, had been in an uptrend for about a year now, so proxy plays like graphite electrode makers were a wise investment option from both growth and value perspective.

Graphite Electrode prices in both high power and ultra-high power grades have begun to firm up after 2 years and have rallied significantly on YOY basis currently.

Although, the demand scenario still appears robust considering China’s aim to ramp up EAF-based steel production and the execution of the scrappage policy in India, valuations and risk-reward have prompted investors to cash in on their recent gains.

Awanish Chandra, Head of Institutional Equities at SMIFS (formerly Stewart & Mackertich Wealth Management)

As covid impact and fear of new waves subsiding around the world, we can witness a gradual pick-up in demand of steel with the recovery in the major steel-consuming industries. Steel prices have risen a lot in 2021 and stagnated recently, hence investors preferred some proxy plays on steel demand such as graphite electrodes, used in electric arc furnace (EAF) based steel mills.

Given that China is controlling its pollution, it has placed emphasis on ramping up steel production by way of electric arc furnaces. Western players have not announced/increased any capacity of graphite electrodes in recent times. All these factors would benefit graphite electrode producers like Graphite India and HEG going ahead.

Technical Outlook

Shares of Graphite India are trading in a symmetrical triangle formation and if the stock gives a breakout of Rs 589 on the lower side, then a fall up to Rs 450 could be expected, said Kkunal Parar, Vice President Research at Choice Broking.

The scrip faces strong resistance at Rs 687 which is also its 100-day moving average level. Parar believes it is not a good time to enter the stock.

Whereas, one could buy HEG if the stock gives a breakout of Rs 2,360 on the upper side. The breakout could trigger further gains in the stock up to Rs 4,000, Parar said.

On the downside though, immediate support is placed at Rs 2,150 and strong support at Rs 1,900.

On Thursday, shares of Graphite India ended 1 percent lower at Rs 627.05 while HEG closed slightly above the flatline at Rs 2,239.85, up 0.1 percent.

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