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Industrials that Benefit from Low Crude Prices

Two companies from the industrials sector that stand to gain from the fall in crude, but a weak client industry could shadow mid-term profits

Industry is a major consumer of crude-based derivatives. Calcined petroleum coke, for instance, constitutes an average of 70 per cent of the total raw material costs for welding equipment manufacturers. Electric equipment manufacturers use base oil, a derivative of crude. Transformer oil is totally dependent on base oil for raw material. Here are two companies that stand to gain from the fall in crude but a weak client industry could shadow mid-term profits.

Graphite India Close to 72 per cent of Graphite India's total raw material costs are crude-based derivatives. That makes Graphite India a major beneficiary of the fall in crude prices. The company is one of the country's top manufacturers of graphite electrodes.

Graphite India's electrodes are used in the electric arc furnace (EAF) method of steel manufacturing. Unlike the traditional blast furnace process, steel factories using the EAF process have the option to start and stop production with a greater operational flexibility as compared to the former. As of CY13, around 27 per cent of the steel produced was through the EAF process. At a time of lower demand, this method of production suits steel manufacturers better.

While Graphite India may have the technological advantage, its fortunes are intricately tied to the global demand for steel. And that is where the bad news comes in. Most steel makers today make money exporting to China, which has so far had an insatiable appetite for steel. That was true until last year when its economy started slowing down and its housing sector went into oversupply. Global steel biggies Rio Tinto and BHP Billiton increased supply. Today there is over-supply of steel - a situation that appears not to change, this year at least. Indian steel manufacturers have started taking hits. Tata Steel saw its net profit plunge 69 per cent (y-o-y) in the December 2014 quarter due to high costs and fall in realisation. Others like JSW Steel have slashed capex by 20 per cent. It is better to stay away from Graphite India for the moment.

Apar Industries Transformer and speciality oils bring in 45 per cent of Apar's revenues. Base oil, a crude oil derivative, constituted 48 per cent of the company's raw material costs (FY14). Falling crude prices bring costs down for companies but they also have the effect of creating losses when inventory has been bought at higher rates. For this reason, the company took a hit in the December 2014 quarter of 80 basis points in the operating profit margin as it liquidated its high-cost base oil inventory. Apar's transformer and speciality oil segment saw revenues decline 16 per cent (y-o-y) in the December 2014 quarter, which saw the volumes decline 7 per cent (y-o-y). The transformer and speciality oil vertical saw a segment EBIT fall of 410 basis points (y-o-y) to 2.5 per cent. That was on account of the high cost inventory the company had.

Apar derives 45 per cent of its revenues from conductors, which have been selling well. With transformer oil vertical down, conductors are driving the company's revenues and earnings for the moment. However, the transformer oil vertical could continue to drag Apar's performance in the coming quarters. Wait for more clarity before buying.