Graftech International Ltd. - Vertically Integrated Cash Flow
Originally Published September 20th, 2022
For those of you that were looking for this in your inbox yesterday were disappointed one more time on a Monday.
But do not be dismayed my value finding friends because the delay was not in vain. There was an article all fired up, ready to drop into your laps that involved a company in the energy industry, but then like a rabid squirrel, my attention was grabbed by another company that is near and dear to my heart.
This company:
Is trading at 3x Price to Earnings
Has a Price to Free Cash Flow < 5
Is at 52 Week Lows
What company am I talking about this week?
Graftech International Ltd. (EAF)
For many of you that have followed myself and my portfolio, you will recognize this name as one that I have been talking about for almost three years. Trust me, there is no recency bias here, in fact I am going to start this value finder with the cons after we take a look at what Graftech does.
Company Description
Graftech in a nutshell creates something called graphite electrodes. These electrodes go inside a type of steel furnace called an Electric Arc Furnace. These furnaces produce steel from scrap metal and are much more environmentally friendly. To check out a full breakdown of the different types of furnaces, click here.
Anyways, these electrodes are actually a consumable good when these furnaces are used, and need to be replaced constantly. This is obviously where GrafTech comes in.
Graftech is a turnaround story essentially, as it was saved by Brookfield Partners after they had put themselves into a bad financialy position. Brookfield then took the company public to capture profits and since then it has been nothing but a downward trajectory for the company’s share price.
Speaking of downward trajectory, let’s go first to the cons of the company.
Cons
Debt Load.
Most of you have come accustomed to seeing companies with very little debt being featured in the Value Finder. GrafTech is not one of these. Actually, GrafTech has a fairly substantial debt load, to the tune of just under $1 billion dollars on revenues of just over that. This is a significant problem when heading into a potential recession and when you are a shareholder looking for returns.
Long Term Agreements.
Something that GrafTech had going for them (and why Mohnish Pabrai held for a time) was that they had highly favorable long term agreements on their books with customers. They had highly advantageous prices per metric ton of electrodes that were well above the current spot prices of the market. These unfortunately are coming to an end this year and it looks like the newer LTAs will have to be negotiated at a much lower price. This definitely isn’t what you like to see when revenues already could be projected to decline.
Mexico Facility Shutdown.
This literally was announced yesterday and sent GrafTech’s stock spiraling down another 10%. While the exact details seem to be murky, Mexico’s regulators have announced they are shutting down GrafTech’s Monterrey, Mexico facility. The inspectors placed a “temporary suspension notice” on the facility and has instructed them to shut down within the next seven days. This facility produces around 25% of electrodes for GrafTech and it could be a major issue.
Pros
The Balance Sheet is Improving.
While the debt is high, no doubt about that, the commitment to the balance sheet improvements have been real. The long term debt has been decreased from $2 Billion to around $900 million since 2018. The current projection is that debt will be paid off over the next 2.5 years and the company will be able to start pushing free cash flow out to investors. There obviously is no guarantees but it seems to be looking up.
Vertical Integration.
While GrafTech is one of the largest producers of graphite electrodes, they are also one of the few producers that actually own their own petroleum needle coke facilities. In 2010, GrafTech purchased SeaDrift Coke, a standalone petroleum coke operator. This is the main material needed to produce graphite electrodes and accounts for much of its price. The big advantage here is that this same product is needed for production of EV batteries. As EVs continue to be produced, the price of this material will as well. This is a competitive advantage for GrafTech as they have some insulation to the price increase.
Buy Backs.
While the company not only has been dedicated to decreasing their debt load, they also have been buying back shares while prices have been at low valuations. Since 2018 the total outstanding shares has decreased by 10% and will continue when seen to be advantageous. As of the start of Q3 GrafTech still had around $99 million in funds authorized to buyback shares, something that at current prices would equate to around 7.5% of outstanding shares.
Conclusion
There should be no surprise to for everyone at this point that I am not only continuing to hold my position in GrafTech but also added to it yesterday on the news of the Mexico facility shutdown.
While revenues are going to decline when the LTAs run their course by the end of the year, the market is currently discounting the shares to pure disaster instead of the free cash flow that the company is producing. The debt load does add challenges to the company, something that doesn’t paint the most near term picture to returns, but instead offers potential for those that have time to wait.
Either way you look at it, it is looking to be a rocky ride for those that hold shares of GrafTech. The company has a lot of things going against them in the short term, but long term the company has a moat that should continue to keep them in a strong position to return profitability to its shareholders. The recent downturn due to a temporary shutdown has given another buying opportunity in my opinion. I will continue to watch closely and add shares of a company that is not only boring, but profitable.
As always, thanks for reading and happy investing!
The Profit Investigator