March 26, 2013 - 8:01pm EST by
2013 2014
Price: 7.48 EPS $0.79 $0.34
Shares Out. (in M): 135 P/E 9.5x 22.0x
Market Cap (in $M): 1,000 P/FCF 9.5x 22.0x
Net Debt (in $M): 550 EBIT 165 98
TEV ($): 1,550 TEV/EBIT 9.0x 16.0x

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  • Steel
  • Manufacturer


Graftech International appears to be an extremely risky and leveraged equity in a commodity industry with the vast majority of its earnings linked to the steel industry. In normal times, this is true. But Graftech's current poor financial performance has given us a phenomenal risk reward opportunity to take advantage of.
In the last two years, GTi has traded down from $22/share to around $7.50 -- and it traded in the $6 range shortly after releasing its 2013 Guidance.
In 2012, GTI earing ~ $0.79/share -- but in 12Q4 GTI released GDNC implying earnings of ~ $0.34/ share implying a 22x multiple. The decline in earnings power is a result of excess capacity in the Graphite Electrode and Needle Coke markets, Graftech's key products.
The excess capacity has led to an expected ~10% decline in electrode and needle coke pricing which will fall almost directly through to the bottom line. The excess capacity is a result of low EAF Steel utilization as well as increased production of low quality graphite electrodes made in China.
Nevertheless, this scenario is obscuring an opportunity to double or triple your money in GTI.
GTI's expected earnings of 34c/share in 2013 dramatically obscure the margin of safety and potential upside:
1) Although GTI will report ~ 34c/share in earnings for 2013, the pro-forma earnings will actually be closer to 45c/share. This is because 2013 is the last year of GTI's and Conoco's Needle Coke take-or-pay arrangement in which GTI has to purchase high priced Needle Coke instead of using its own internally produced Needle Coke. This arrangement will cost GTI ~$20m in '13 per management's comments and adds another ~11c/share to GTI's earnings going forward.
2) Given the extremely low profitability of GTI's electrode business, at 45c/share, its business mix is MUCH more attractive than it appears at normal levels. At 45c/share, around 1/2 of GTI's earnings come from its Engineered Solutions segment which produces high value added advanced graphite materials for critical engineering applications. This segment is growing double digits with double digit margins. When the Electrode segment is under normal circumstances, it produces the vast majority of GTI's profits.
3) There's not much earnings downside left -- GTI is a low-cost producer of electrodes in part because its CEO, Craig Shular, is maniacal about cost controls, and in part because it is the only vertically integrated graphite electrode producer which has its own Needle Coke supply. Already mgmt has strong suspicions that the Chinese electrode suppliers are not profitable -- using GTI as a good example, the industry simply cannot afford another round of price cuts. If pricing gets cut further, none of the electrode companies will make any money. Graphite Electrodes are an essential consumable input to EAF steel production -- you can't make EAF steel w/o it. So while it may be painful in the near term -- the electrode industry needs to exist, and GTI is the only vertically integrated, low-cost supplier. Any further price cuts would be an opportunity for GTI as it will be able to make attractive acquisitions of distressed suppliers and consolidate the industry.
4) Even at 45c/share, GTI's earnings power is obscured -- The 45c/share is based on the full-year #s -- but as the industry works off inventory, GTI will actually EXIT '13 earning ~ 72c/share based on their GDNC.
5) So here we have GTI trading at ~10x 2013Q4 run-rate earnings -- but that's not all. GTI's capacity utilization has typically peaked in the low 90s  -- but the 72c/share is based on a utilization of low 80s. Every 10pct increase in utilization adds another 30-35c/share, so when utilization picks up, GTI will be earning north of $1.00/share.
6) And in the scenario where utilization picks up, pricing will pick -- so if we imagine GTI simply REGAINS the pricing it lost in '13, ~10%, that would add another 50-60c/share.
7) So in an up scenario, GTI could be earnings ~72c ('13Q4 run-rate earnings) + 34c (impact from 10pct utilization improvement) + 55c (10% pricing improvement) = ~$1.60
8) GTI stock is currently trading at $7.50 -- so in an up scenario where capacity gets tight again, GTI could easily double or more. And the downside is relatively limited because, as discussed above, it is currently earning 45c/share pro-forma for 2013 and because of its Engineered Solutions business, these earnings will grow at mid to high single digits which fully supports the current valuation.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


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