GRAFTECH INTERNATIONAL LTD BAM2
April 11, 2018 - 8:33am EST by
puppyeh
2018 2019
Price: 22.50 EPS 2.6 3.6
Shares Out. (in M): 302 P/E 8.7 6.3
Market Cap (in $M): 6,800 P/FCF 8.6 6.3
Net Debt (in $M): 1,715 EBIT 1,095 1,423
TEV ($): 8,515 TEV/EBIT 0 0

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  • Looks good on a spreadsheet
  • Still the next Tronox
 

Description

Thesis summary: Writing up an IPO on VIC may seem a little unusual and perhaps I am temping fate, but Graftech (EAF will be the new code) seems such a compelling proposition that I am going to go ahead and do it anyway. If you purchase EAF at the mid-point of the IPO range (I believe the book closes next week so unsure on final pricing), I believe you are buying the only vertically-integrated producer of graphite electrodes (GE) at ~5x EV/EBITDA, 6x FCF and 6x P/E on my 2019E numbers - with very little if any upside baked in for higher spot prices. This is for a business where 2/3 of volumes have been pre-sold (for five years) at levels that imply ~65%+ EBITDA margins (and near 40% returns on invested capital); where you are by far the lowest cost producer in an industry operating at 100% utilization already, with both significant barriers to entry and a strong secular growth outlook; where you are the only name in the industry capable of meaningfully growing production capacity (due to raw material shortages); and where the selling shareholder has already set the tone re capital returns (ie, a lot will be forthcoming). I feel the 'right' price for a business like this is at least 10x FCF as a starter and see no reason why it will remain on pure commodity-cyclical valuations (where it is being sold in the IPO) given its new business profile. This re-rating alone would suggest 50% upside in a year, outside of excess capital returns. Keep in mind that other GE names of much less quality in India and China, trade at high single digit EBITDA multiples; while the Japanese comps - with 30pt lower EBITDA margins and much less visibility - trade at 5x EBITDA; meanwhile other specialty carbon names (which EAF could easily claim to be, over time), tend to trade on double digit EBITDA multiples. This opportunity exists because a) Brookfield has already made 10x on this investment; b) Brookfield is only selling 15% of the company (and so is motivated to leave some money on the table now for future offerings); and c) there is a historical taint on the industry given the deep cyclicality of the business in the past (which I think no longer really applies).

Graftech will be listing with a ~$7bn market cap and around $900mm in free float so should be liquid enough for most all funds. This will not be a long write-up as the case is pretty clear. There is an online roadshow available (through JPM/Citi/other bookrunners) with a lot of useful information. Graftech has been written up three times in the past, (two long, one short) but all three writeups were more idiosyncratic and before the recent restructuring of the industry, so are of limited value to the thesis today.

Quick background: Graftech makes graphite electrodes (GE). GE are used to produce steel in an electric arc furnace, the dominant method of steel production in the US (but not globally, where blast furnaces are still dominant). Graphite is used because it is the only material that has the chemical properties to adequately pass a current consistently at the temperatures needed to produce steel in an EAF (around 1800C) - hence there is no substitute for this product. Ultra-high performance (UHP) electrodes - Graftech's specialty - can take up to 6months to produce and yet are consumed in one single 8-10hour shift. Despite the recent massive rally in prices (GE prices went from $3k/t in 2016 to $10k/t now, at the contract level, while spot pricing in some markets ins $15-30k/t), GE still constitute a small portion of the value of the steel produced. For example, even at $10k per ton, the cost of GE needed to produce 1t of HRC steel from an EAF is around 2% of the value of the product. This is a very important consideration as it clearly means that steel producers value quality of product, consistency of supply, and performance of electrodes far more than the price paid.

For most of the past 10yrs GE was a typical volatile commodity product, beset by vicious pricing swings. This changed rapidly in the last 18mos or so due to a confluence of factors:

- tightening Chinese steel markets increasing global steelmaking utilization

- increasing environmental standards making new-build GE capacity in China very difficult

- increasing EAF (vs BOF) steelmaking demand

- removal of 20% of high-cost capacity through rationalization (including some done by Graftech)

- consolidation in the industry (no 2 and no 3 players merged)

- and, most importantly, the development of an alternate use-case for the key input cost into GE, needle coke (it is used as an anode material in LiB batteries)

This last point is the most important, because it essentially has created a new secondary market for needle coke - the only input for UHP GE. This end market, LiB batteries, is growing (in demand terms) by 30% (according to some analysts) and already constitutes 10% of the total demand for needle coke. Today, the GE market is operating at 100% utilization, but there is no way to source additional GE because it can only be made from needle coke (for high quality GE), which is itself at full utilization. New capacity takes a long time to bring online because needle coke is essentially a by-product of the refining process (made from a very small portion of the output slate), so other than de-bottlenecking, it is quite hard to bring new, dedicated capacity online. Graftech estimates it will take at least 5yrs to see meaningful needle coke capacity emerge outside of China, and perhaps longer than that to see real GE capacity emerge as well.

In the meantime, Graftech is the only vertically integrated GE producer globally because it owns Seadrift Coke - a captive source of 140kt of needle coke per year (versus 170kt annual GE production, rising to 200-230kt over next two years). There are only 5 global facilities that can produce the quality of needle coke at scale needed for UHP, and Graftech owns one of them (while >50% of the rest of ex-China capacity is owned by Philips 66). This is why spot prices for GE have risen so far, so fast - it remains a small component of the cost of production for steelmakers, it is completely essential, and it cannot be easily sourced in the current environment.

Cost push has been the primary driver of GE price expansion in the last year or so (even though GE prices have expanded far more) but the key point is because Graftech is vertically integrated on ~75% of its production, it is the sustainable low-cost producer. In 1Q'18, Graftech says their vertically-integrated total cash costs per ton ($2600/t) is lower than the cost of needle coke alone in the spot market (around $3000/t). Essentially then Graftech has at least ~$3500/t advantage versus marginal producers, hugely insulating it from the next downturn (whenever it comes, if it comes). Thus, for example, even at $7k/t - assuming needle coke prices didnt come down as well - Graftech would be making mid-40s% EBITDA margins (ie 5-10pts higher than comps today). Still, it is unlikely prices fall below current contract price levels (ie $10k/t) when all clients are happy to buy as much GE (five years out) at $10k/t if they could secure the supply.

The Changing Nature of the Industry: nothing speaks more to the 'new normal' in GE than Graftech's new pricing/contract structure. This industry used to be subject to huge annual or semi-annual earnings changes as contracts were negotiated with steelmakers on this basis; with the industry plagued by over-capacity for a long time, this meant there was very little visibility to earnings and cashflows out more than say one year (similar to many pure commodity industries). However Graftech, a few months ago, sold forward  for five years (via take-or-pay contracts) around 2/3 of their production at around $10k/t - essentially locking in 60%+ EBITDA margins, I think - to willing buyers. To me, this underlines the much improved industry structure: steelmakers would simply be unwilling to commit in this way if they thought the current level of pricing was either unfair or unsustainable. I am not sure the market really understands how significant this was/is, but to me it clearly suggests a much healthier, more viable industry (and thus deserving of a non-commodity multiple) once the market gets its head around the consequences.

Valuation: As mentioned in the intro, I think on next year's numbers, Graftech is coming around 5x EV/EBITDA, 6x FCF and 6x P/E (with only 1.5x of leverage at end-this year, falling to 0.5x end next year even assuming they pay a 5% yield). That, to me, sounds very much like a discounted, top-of-cycle commodity multiple for a business where the market expects cash flows to fall significantly in the out-years. However, that won't happen for at least 5yrs, given the hedging profile of the company (they have hedged production costs on the integrated volumes, too), and instead I see a business where the end-product is likely to stay tight for the foreseeable future; where new capacity is not likely to affect delivered volumes for at least 5yrs; where you can own the low-cost producer with the only opportunity to organically grow in the industry; and, significantly, where you are completely aligned with majority owners (Brookfield) who clearly want to upstream cash (hence the large divs paid out pre-IPO and commitment towards a target leverage ratio, 1.5x, that implies huge shareholder returns).

Looking at a variety of steel/other commodity names, pure price-taker commodity businesses like steel cos trade at 4-5x EBITDA currently, while better (but still commodity) businesses with low visibility like BHP/RIO/etc, trade at 5-6x EBITDA and around 9-10x FCF. This is where (on a FCF basis) much lower-quality Japanese/Chinese/Indian graphite names trade as well - none of which are vertically integrated, have hedged 5yrs of sales, are listed in the US, have this size market cap and likely analyst coverage, nor commitment to large-scale capital returns. I would argue a similar multiple on FCF is justified at a bare minimum - and I am not even pricing in much upside for where prices currently trade (say, $20k/t), as I am essentially assuming just $10.8k/t average pricing next year (and $10.5k/t the year after). Even so, 10x FCF gets me to $36/share on FY19E numbers, excluding any excess capital returns, ie a likely 50% IRR from here. At that level I think the stock would be at 8x EBITDA going on 7x 2020E, still reasonable in my mind.

It is also worth noting that when Graftech was previously listed, as bad as this industry was historically, the average EV/EBITDA multiple was 10-12x over the last 8yrs (and the business was much more levered). So there could really be much more upside, even if it takes more time to get there.

Why is it so cheap? Ok, the obligatory 'what am I missing' section. There are a few potential reasons, I think most make sense and I'm comfortable with the thought process, but please feel free to disagree in the comments:

- Brookfield is a price insensitive seller: Brookfield bought this for $800mm in 2015, and, while they may have invested some more capital during the early dark days, they are effectively clearing nearly a 10x on this ($7bn equity valuation + $2bn and change in divs). They don't need to sell this at full value right now, especially because...

- Brookfield is only selling 15%: I think they want the deal to go well as they have a lot of stock to sell later; at the same time I think they recognize this is too cheap to sell all their position so they are motivated to see it trade better as well. In the meantime they are highly motivated to keep paying huge special divs...which helps us as minorities

- The taint of history: pretty clear really, there will be a ton of non-believers who think this is the same old crappy industry (cf, MU and the memory industry), who aren't willing to pay for the structural improvement or Graftech's new-found contractual visibility. OK, i get it, but I am also comfortable thinking this will come over time, especially as shareholder returns accumulate

- No comps: this is a pretty niche industry and there aren't any US-listed comps, while the global comps are few (a couple of Japanese, a couple Indian) and not the simplest (they have other ancillary businesses). I can see a number of managers throwing it in the 'China risk' bucket and approach later on once it has listed/gets coverage

 

I think that is really about it. I think this is about as good as a mid-cap IPO can get, happy to talk more about the risks in the comments.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

They print massive quarterly FCF and EBITDA margins and return huge gobs of capital via dividends/buybacks

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    Description

    Thesis summary: Writing up an IPO on VIC may seem a little unusual and perhaps I am temping fate, but Graftech (EAF will be the new code) seems such a compelling proposition that I am going to go ahead and do it anyway. If you purchase EAF at the mid-point of the IPO range (I believe the book closes next week so unsure on final pricing), I believe you are buying the only vertically-integrated producer of graphite electrodes (GE) at ~5x EV/EBITDA, 6x FCF and 6x P/E on my 2019E numbers - with very little if any upside baked in for higher spot prices. This is for a business where 2/3 of volumes have been pre-sold (for five years) at levels that imply ~65%+ EBITDA margins (and near 40% returns on invested capital); where you are by far the lowest cost producer in an industry operating at 100% utilization already, with both significant barriers to entry and a strong secular growth outlook; where you are the only name in the industry capable of meaningfully growing production capacity (due to raw material shortages); and where the selling shareholder has already set the tone re capital returns (ie, a lot will be forthcoming). I feel the 'right' price for a business like this is at least 10x FCF as a starter and see no reason why it will remain on pure commodity-cyclical valuations (where it is being sold in the IPO) given its new business profile. This re-rating alone would suggest 50% upside in a year, outside of excess capital returns. Keep in mind that other GE names of much less quality in India and China, trade at high single digit EBITDA multiples; while the Japanese comps - with 30pt lower EBITDA margins and much less visibility - trade at 5x EBITDA; meanwhile other specialty carbon names (which EAF could easily claim to be, over time), tend to trade on double digit EBITDA multiples. This opportunity exists because a) Brookfield has already made 10x on this investment; b) Brookfield is only selling 15% of the company (and so is motivated to leave some money on the table now for future offerings); and c) there is a historical taint on the industry given the deep cyclicality of the business in the past (which I think no longer really applies).

    Graftech will be listing with a ~$7bn market cap and around $900mm in free float so should be liquid enough for most all funds. This will not be a long write-up as the case is pretty clear. There is an online roadshow available (through JPM/Citi/other bookrunners) with a lot of useful information. Graftech has been written up three times in the past, (two long, one short) but all three writeups were more idiosyncratic and before the recent restructuring of the industry, so are of limited value to the thesis today.

    Quick background: Graftech makes graphite electrodes (GE). GE are used to produce steel in an electric arc furnace, the dominant method of steel production in the US (but not globally, where blast furnaces are still dominant). Graphite is used because it is the only material that has the chemical properties to adequately pass a current consistently at the temperatures needed to produce steel in an EAF (around 1800C) - hence there is no substitute for this product. Ultra-high performance (UHP) electrodes - Graftech's specialty - can take up to 6months to produce and yet are consumed in one single 8-10hour shift. Despite the recent massive rally in prices (GE prices went from $3k/t in 2016 to $10k/t now, at the contract level, while spot pricing in some markets ins $15-30k/t), GE still constitute a small portion of the value of the steel produced. For example, even at $10k per ton, the cost of GE needed to produce 1t of HRC steel from an EAF is around 2% of the value of the product. This is a very important consideration as it clearly means that steel producers value quality of product, consistency of supply, and performance of electrodes far more than the price paid.

    For most of the past 10yrs GE was a typical volatile commodity product, beset by vicious pricing swings. This changed rapidly in the last 18mos or so due to a confluence of factors:

    - tightening Chinese steel markets increasing global steelmaking utilization

    - increasing environmental standards making new-build GE capacity in China very difficult

    - increasing EAF (vs BOF) steelmaking demand

    - removal of 20% of high-cost capacity through rationalization (including some done by Graftech)

    - consolidation in the industry (no 2 and no 3 players merged)

    - and, most importantly, the development of an alternate use-case for the key input cost into GE, needle coke (it is used as an anode material in LiB batteries)

    This last point is the most important, because it essentially has created a new secondary market for needle coke - the only input for UHP GE. This end market, LiB batteries, is growing (in demand terms) by 30% (according to some analysts) and already constitutes 10% of the total demand for needle coke. Today, the GE market is operating at 100% utilization, but there is no way to source additional GE because it can only be made from needle coke (for high quality GE), which is itself at full utilization. New capacity takes a long time to bring online because needle coke is essentially a by-product of the refining process (made from a very small portion of the output slate), so other than de-bottlenecking, it is quite hard to bring new, dedicated capacity online. Graftech estimates it will take at least 5yrs to see meaningful needle coke capacity emerge outside of China, and perhaps longer than that to see real GE capacity emerge as well.

    In the meantime, Graftech is the only vertically integrated GE producer globally because it owns Seadrift Coke - a captive source of 140kt of needle coke per year (versus 170kt annual GE production, rising to 200-230kt over next two years). There are only 5 global facilities that can produce the quality of needle coke at scale needed for UHP, and Graftech owns one of them (while >50% of the rest of ex-China capacity is owned by Philips 66). This is why spot prices for GE have risen so far, so fast - it remains a small component of the cost of production for steelmakers, it is completely essential, and it cannot be easily sourced in the current environment.

    Cost push has been the primary driver of GE price expansion in the last year or so (even though GE prices have expanded far more) but the key point is because Graftech is vertically integrated on ~75% of its production, it is the sustainable low-cost producer. In 1Q'18, Graftech says their vertically-integrated total cash costs per ton ($2600/t) is lower than the cost of needle coke alone in the spot market (around $3000/t). Essentially then Graftech has at least ~$3500/t advantage versus marginal producers, hugely insulating it from the next downturn (whenever it comes, if it comes). Thus, for example, even at $7k/t - assuming needle coke prices didnt come down as well - Graftech would be making mid-40s% EBITDA margins (ie 5-10pts higher than comps today). Still, it is unlikely prices fall below current contract price levels (ie $10k/t) when all clients are happy to buy as much GE (five years out) at $10k/t if they could secure the supply.

    The Changing Nature of the Industry: nothing speaks more to the 'new normal' in GE than Graftech's new pricing/contract structure. This industry used to be subject to huge annual or semi-annual earnings changes as contracts were negotiated with steelmakers on this basis; with the industry plagued by over-capacity for a long time, this meant there was very little visibility to earnings and cashflows out more than say one year (similar to many pure commodity industries). However Graftech, a few months ago, sold forward  for five years (via take-or-pay contracts) around 2/3 of their production at around $10k/t - essentially locking in 60%+ EBITDA margins, I think - to willing buyers. To me, this underlines the much improved industry structure: steelmakers would simply be unwilling to commit in this way if they thought the current level of pricing was either unfair or unsustainable. I am not sure the market really understands how significant this was/is, but to me it clearly suggests a much healthier, more viable industry (and thus deserving of a non-commodity multiple) once the market gets its head around the consequences.

    Valuation: As mentioned in the intro, I think on next year's numbers, Graftech is coming around 5x EV/EBITDA, 6x FCF and 6x P/E (with only 1.5x of leverage at end-this year, falling to 0.5x end next year even assuming they pay a 5% yield). That, to me, sounds very much like a discounted, top-of-cycle commodity multiple for a business where the market expects cash flows to fall significantly in the out-years. However, that won't happen for at least 5yrs, given the hedging profile of the company (they have hedged production costs on the integrated volumes, too), and instead I see a business where the end-product is likely to stay tight for the foreseeable future; where new capacity is not likely to affect delivered volumes for at least 5yrs; where you can own the low-cost producer with the only opportunity to organically grow in the industry; and, significantly, where you are completely aligned with majority owners (Brookfield) who clearly want to upstream cash (hence the large divs paid out pre-IPO and commitment towards a target leverage ratio, 1.5x, that implies huge shareholder returns).

    Looking at a variety of steel/other commodity names, pure price-taker commodity businesses like steel cos trade at 4-5x EBITDA currently, while better (but still commodity) businesses with low visibility like BHP/RIO/etc, trade at 5-6x EBITDA and around 9-10x FCF. This is where (on a FCF basis) much lower-quality Japanese/Chinese/Indian graphite names trade as well - none of which are vertically integrated, have hedged 5yrs of sales, are listed in the US, have this size market cap and likely analyst coverage, nor commitment to large-scale capital returns. I would argue a similar multiple on FCF is justified at a bare minimum - and I am not even pricing in much upside for where prices currently trade (say, $20k/t), as I am essentially assuming just $10.8k/t average pricing next year (and $10.5k/t the year after). Even so, 10x FCF gets me to $36/share on FY19E numbers, excluding any excess capital returns, ie a likely 50% IRR from here. At that level I think the stock would be at 8x EBITDA going on 7x 2020E, still reasonable in my mind.

    It is also worth noting that when Graftech was previously listed, as bad as this industry was historically, the average EV/EBITDA multiple was 10-12x over the last 8yrs (and the business was much more levered). So there could really be much more upside, even if it takes more time to get there.

    Why is it so cheap? Ok, the obligatory 'what am I missing' section. There are a few potential reasons, I think most make sense and I'm comfortable with the thought process, but please feel free to disagree in the comments:

    - Brookfield is a price insensitive seller: Brookfield bought this for $800mm in 2015, and, while they may have invested some more capital during the early dark days, they are effectively clearing nearly a 10x on this ($7bn equity valuation + $2bn and change in divs). They don't need to sell this at full value right now, especially because...

    - Brookfield is only selling 15%: I think they want the deal to go well as they have a lot of stock to sell later; at the same time I think they recognize this is too cheap to sell all their position so they are motivated to see it trade better as well. In the meantime they are highly motivated to keep paying huge special divs...which helps us as minorities

    - The taint of history: pretty clear really, there will be a ton of non-believers who think this is the same old crappy industry (cf, MU and the memory industry), who aren't willing to pay for the structural improvement or Graftech's new-found contractual visibility. OK, i get it, but I am also comfortable thinking this will come over time, especially as shareholder returns accumulate

    - No comps: this is a pretty niche industry and there aren't any US-listed comps, while the global comps are few (a couple of Japanese, a couple Indian) and not the simplest (they have other ancillary businesses). I can see a number of managers throwing it in the 'China risk' bucket and approach later on once it has listed/gets coverage

     

    I think that is really about it. I think this is about as good as a mid-cap IPO can get, happy to talk more about the risks in the comments.

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    They print massive quarterly FCF and EBITDA margins and return huge gobs of capital via dividends/buybacks

    Messages


    SubjectBacklog less net debt?
    Entry04/11/2018 02:26 PM
    Memberafgtt2008

    Thanks for the idea puppyeh. Sounds like the industry has improved significantly. Just for a valuation starting point, how does the undiscounted value of the backlog per share less the net debt per share compare to the offering price?


    Subjecthow sustainable is the needle coke shortage
    Entry04/11/2018 04:02 PM
    Memberima

    i started doing some work on this IPO and peers. one key factor is shortage of needle coke.

    when ROICs are this high, i get uncomfortable underwiting these economics far out into the future. it seems different than MU. more players, lower barriers.

    why can't one of the big japanese players announce a plant that will add 10% to capacity by 2020? plus my work suggests room for debottlenecking that will add 10% to production...

    given the high ROIC, ~50% for needle coke with long term contracts, > 75% at spot.... why wouldn't the high quality needle coke makers add capacity? what about 2nd rate needle coke players? could customers trade down to mediocre quality?

    can customers substitute from needle coke? battery might be able to (to natural graphite)? could graphite electrode companies find ways to use less needle coke per unit? etc...

     

    thanks!

     


    SubjectSome #s
    Entry04/11/2018 05:03 PM
    Memberzzz007

    This is an interesting idea. I have gone through the online roadshow. For others who are interested you can find it at

    https://www.retailroadshow.com/

    My thoughts after going through the presentation are as follows.

    I agree with ima. With 40% ROICs (or higher), additional capacity is a question of when, not if. Mgmt is claiming 5+ years for new greenfield capacity to come online. The question is what financials look like after that point in time.

    Some other notes from the roadshow presentation:

    * Mgmt says adj EBITDA 1Q 2018 = $305mm (or $1.2bn annlzd), with monster FCF conversion netting $295 (or thereabouts) of FCF.

    * 2019 > 2018 b/c bringing some warm idled capacity back online. Looks like roughly 35% capacity growth for 2019.

    So, with TEV of $8,515, trading at 7x 2018 EBITDA and bumping EBITDA by the 35% capacity growth for 2019 yields the 5x that puppyeh references.

    Contracted 5-yr backlog of 636k MT @ $9,700/MT so aggregate = $6.2bn revenue. So, afgtt, contracted backlog less net debt = $4.5bn, or roughly $15/shr vs. $22.50/shr assumed offering price.

    FCF conversion seems unsustainably high at 97%. So, for super duper conservative rough cut, I am going to assume that more reasonable FCF conversion ratio is offset by 35% increase in capacity. 5 years of $1.2bn FCF/annum (1Q rate of $295mm annlzd) = $6.0bn aggregate. Subtract debt of $1.7bn yields $4.3bn FCF accreting to equity, or $14.25/shr. So we are paying $22.50/shr and getting $14.25/shr of that back over the next 5 years in FCF under the theoretical assumption that all FCF gets paid out to s/h.

    The $20k question is what does our EPS/FCF look like post year-5 in a more normalized environment after additional capacity comes online and pricing stabilizes?

    The past is not reassuring, as average annual adj EBITDA between 2014 and 2017 was just $65mm. Peak EBITDA in that four year period was $121mm (2014). So even if all FCF (after paying down the debt) was returned to shareholders over the next five years (leaving us with an adjusted cost basis of $22.50 - $14.25 = $8.25/shr), this would be trading 5 years out at >20x peak EBITDA from 2014-17. On the other hand, it would be trading at just 2x 1Q 2018 annlzd EBITDA...hence, why puppyeh is focusing on this being a situation where there is a new normal.

    So, for me, the question is where does that "new" normalized EBITDA fall out w/new capacity coming online 5-years out. Somewhere between prior $65mm avg and new $1,600mm 2019 (possibly "peak") EBITDA. I don't know.

    Maybe projecting out five years is a fool's errand, and the way to think about this is that there will be at least a few Qs of improving pricing + monster FCF so the stock should trade up into peak year of 2019...


    SubjectRe: Some #s
    Entry04/11/2018 05:19 PM
    Memberzzz007

    So on further, thought, maybe I am going about this backwards. Instead of trying to figure out what pricing should look like in 5+ years, maybe the right way to go about it is to start with a normalized ROIC.

    15% ROIC seems reasonable, if not generous to me. I can see capacity getting added continually until that ROIC is reached industry-wide.

    If we assume 15% ROIC and ignore leverage, that would imply that steady-state EBIT/earnings/FCF for GrafTech 5+ years out would be 35-40% of peak levels (assuming 40% currently peak ROIC), or $440mm per annum.

    I put a 12x multiple on that $440mm and get equity terminal value of $5.3bn or $17.50/shr. Discount that back 5 years @ (pick your rate) = $12ish/share + the $14.25/shr (undiscounted) over the next five years yields ballpark mid-high $20s vs. the $22.50/shr offering price.

    Lots of assumptions...


    SubjectRe: Re: Some #s
    Entry04/11/2018 06:53 PM
    MemberBismarck

    China will determine whether these market conditions sustain themselves.

    Payback for Chinese GE plants are silly today at 3-6 months. Large Chinese needle coke and graphite electrode supply are coming online by mid 2019. Construction of these plants were stopped halfway in the NC/GE downturn of 2014-2016. Finishing them would only take 1-2 years and construction restarted in mid 2017. 

    Once Chinese NC/GE supply re-balances, Chinese GE exports will go back to pre-2017 shock levels. 40% of Europe's GE needs pre-2017 shock was coming from China so European EAFs will be able to get access to Chinese GEs again. Same thing for Middle Eastern EAFs. That will result in less than peak demand for Japanese and American graphite electrodes, which will cause prices to decrease.

    Two potential added kickers on the downside: 1) peaked Chinese steel demand and 2) slower than expected ramp up of Chinese EAF conversions. Infrastructure steel demand has peaked and started turning negative. A lot of EAF steel goes into infrastructure. This would negatively impact Chinese EAF steel production, which would exacerbate the effects from the addition of new GE supply. 

    Furthermore, Chinese EAF conversions from BF will be less than people think given high scrap prices, low availability of good scrap etc. 

    Lastly, these take or pay contracts allow enough room for pricing renegotiation should market prices go down significantly. Thus, the 5 year $10-11k prices are most definitely not sustainable even in a downturn. Genius of Brookfield to negotiate these contracts to sell the IPO story.


    SubjectRe: Backlog less net debt?
    Entry04/12/2018 04:25 AM
    Memberpuppyeh

    hi afgtt, thanks for the comment. Re your question, not sure if zzz answered it for me, but the committed backlog less net debt is around $4.5bn, or around $15/share (and the offer range is $21-24/share). note that they have only pre-sold around 65% volumes so you'd then have to accord some value for the remaining production (presumably to be filled at spot prices, unless they decide to hedge up more in the coming years), as well as the ongoing business beyond the contract period.


    SubjectRe: how sustainable is the needle coke shortage
    Entry04/12/2018 04:52 AM
    Memberpuppyeh

    hi Ima, you raise a number of interesting questions which go to the heart of the debate. Clearly there is a ton of deep-seated skepticism about the current situation persisting. Let's talk a little about needle coke specifically:

    - there are only two sources of needle coke: oil-based ('petroleum needle coke') and coal-based ('pitch needle coke') which are both by-products (of the refining process, and the coking process, respectively)

    - there are quality differences between types of needle coke, generally speaking pet needle coke is higher quality and harder to produce

    - petroleum needle coke is just one of type of pet coke (there are 4 main types), all of which come from a small portion of the output slate of a refinery (essentially the tar/asphalt part which is generally <10% of the output of a barrel of WTI crude). You need to take the tar, put it through a coker, which creates the various kinds of pet cokes, of which at least 80% are fuel-grade (ie not good enough to make electrodes), which all means that maximum 2% of the input barrel can ever end up as needle coke. This is why you can't simply flick a switch and create more capacity because you would need to make the other 98% of slate too which has completely unrelated economics (and drives the investment decision)

    - there are only 5 facilities globally that produce high quality petroleum needle coke (Graftech owns 1), with Philips 66 controlling 50% of the total ex-China market, so I don't really agree with your contention that this is a crowded market with low barriers to entry

    - there has been no new pet coke capacity added since the 1980s (outside of China), supporting the contention that it is not easy to simply bring new capacity online

    This explains why - despite the massive price rally - you haven't seen any of the major producers talk about new greenfield capacity. It is not simply a matter of deciding just to make needle coke, you need to be happy to produce the whole slate.

    Debottlenecking - yes, to the extent possible, of course refiners will try to maximize needle coke yields. This would involve using heavier crude (if their refineries permit it), for example - although again this depends on the refinery and (in the case of Philips 66) they are undoubtedly geared to input lighter WTI than other, heavier crudes. Despite the rally in prices for needle coke (from say $500/t to $3000/t), that kind of move on 2% of the output slate is still basically irrelevant to the decisions of the broader refinery. However even if we see 10% increase to production over 3 years (since de-bottlenecking takes time) from this, as you claim, this would simply only meet the growing demand from EVs (currently growing at 30% CAGR and already 10% of the total needle coke demand). So I don't see how supply/demand weakens meaningfully from this (EAF steelmaking is still a secular growth market).

    2nd rate players: I will deal with this more on some other comments but essentially China is trying to build a lot of new capacity. Much of this comes from coal, which is generally lower quality, and often not good enough to produce reliable anodes. Remember that customers care about operational integrity much more than cost given GE is only 1-2% of the cost of the end product. Frankly speaking, there may be some who end up buying lower-quality product from China in a number of years, but not the premium US/European mills who are Graftech's clients.

    Substitutes: There is no subsititute for needle coke to produce GE. There may end up being an alternate anode material for EV batteries - but this would likely be driven by economics (in other words needle coke prices would have to rise to such a point where it was more economic to switch to similarly conductive/chemically appropriate materials than a carbon-based material). Carbon - 90% of needle coke is carbon - is by far the most abundant element and - even finished into needle coke at current prices - should still be significantly cheaper than any metal-based solution for a long long time.

     


    SubjectRe: Re: Some #s
    Entry04/12/2018 05:18 AM
    Memberpuppyeh

    zzz, thank you for your comments. Yes, clearly this is a really bad idea if the past cyclicality comes back to bite. one way to think about it might be: if they pay out all the FCF over the life of the contract (I think they will or come close), what does the residual imply for the earnings power of the business post 2022. Thus, on my numbers, I think they will generate around $5.1bn in FCF over the next 5yrs, or call it $4.3bn discounted, which would leave the adjusted EV at $22.5/share at $4.2bn. If you are willing to grant a historical EBITDA multiple, say 10x, essentially you would then need to underwrite $420mm of EBITDA in 2023 vs I think $1.4bn of EBITDA next year, or something like $1830 of EBITDA/t (on the built-out footprint post 2020) versus current profitability of $7000/t. 

    Given the feedstock advantage, if Graftech was back earning below $2k/t then all the competition would most likely be loss-making at the EBITDA level and presumably capacity would be being shuttered again. It is always hard to speculate 5yrs into the future but I don't think that is a base-case outcome, and part of the reason I think the share are too cheap.


    SubjectFrom Platts
    Entry04/12/2018 09:38 AM
    MemberdoctorK

    China granted approvals for the installation of new steelmaking facilities with a capacity of 149.8 million mt a year between the start of 2017 and April 2018, predicated on the closure of 169.7 million mt/year as part of its capacity replacement campaign, S&P Global Platts calculations based on Chinese local government announcements show.

    The new capacity, most of which has no fixed timetable, will come on stream mainly over 2018-20. Most of the closures will be carried out once new facilities are commissioned.

    Of the total new capacity, 51.4 million mt/year, or 34%, will use electric arc furnaces, while the rest will be converters.

    Some 11 million mt/year of this new EAF capacity Will replace converters, while the rest will be the replacement of existing EAFs.

    China has been encouraging steel mills to switch from blast furnaces and converters to EAFs since 2017. This is because EAFs are more environmentally friendly, and the supply of ferrous scrap has grown after the elimination of 140 million mt/year of induction furnace capacity in 2017.

    Some market sources said the switch from blast furnaces and converters to EAFs would be slow as scrap supply has been unstable and inadequate. However, some said the trend would be irreversible because as China's fight against air pollution continues the frequent and stringent output controls at blast furnaces would encourage steelmakers to shift gradually to EAFs, which would be spared output cut orders during bad weather.

    Meanwhile, from the start of 2017 to April 2018, approvals granted for new pig iron making facilities -- blast furnaces, has totaled a combined capacity of 111.66 million mt/year, also predicated on the shutting down of existing blast furnaces with a pig-iron capacity of 130.3 million mt/year.


    SubjectRe: Re: Re: Some #s
    Entry04/13/2018 11:08 AM
    Memberpuppyeh

    Bismarck, thanks for your comments. I think you make three main pushbacks - Chinese production will come online very quickly; Chinese exports will displace American/Japanese products in global markets; and take or pay contracts are not binding on price. Lets look at each in turn:

    Speed of Chinese production coming online: there have been a couple of sell-side notes cautious about Chinese capacity coming back online and how this will affect Chinese spot prices (one broker in particular, Nomura). I think you (and him) are massively over-estimating the ability of Chinese production to come back online rapidly. Yes, pay-backs may be extremely short at current spot prices - assuming the Chinese can actually build what they say they can and at stated capex budgets; but I think a lot of these numbers are hot air. With regard to needle coke capacity in China, the major producers now are Shanxi Hongte (150ktpa, from coal), Sinosteel Anshan, Fangda Carbon, Bao Steel, and Jinzhou Petrochem. Note that of the planned needle coke capacity increases in China - 180ktpa for 2018, 250kt for 2019, and 290kt for 2020 - very little (around 20%) is coming from established players (ie Shanxi Hongte and Fangda). The remaining 80% of capacity will come from new, smaller players with (I believe) limited track record in producing needle coke - let alone the quality of product needed for UHP electrodes.

    For one of the facility expansions being planned - Baotai Long's 50kt facility, indeed one of the facilities you referred to as being partially complete - construction of the original facility took 5yrs (2011-2016), but then an additional year before it produced any electrodes (and by then needle coke prices had skyrocketed, October 2017). Even today, the management is on the record as saying the plant suffers from operational issues and poor quality feedstock coal tar, so I wouldn't underwrite this capacity coming online this year at all.

    Another example - the Bao Steel project (50kt of needle coke, online by 2020, construction done in 2+ years, for a cost of ~700mm RMB). I really dont think this is possible - it is the same size as a new-build Posco Chemtech plant in Korea, which took 4+ years to build at 3.5x the cost (despite also saying it would take 2yrs orginally). Even incumbents like Fangda have also promised to build plants in 2yrs that end up taking 5yrs...

    In any case you will note that most all the Chinese capacity is derived from coal tar, not petroleum needle coke. As mentioned in another comment, this is generally of lower quality (hence the Baotai Long point) and not suitable for UHP electrodes. Further, it is quite difficult to maintain product yields of pet-based needle coke which is why Jinzhou - the only Chinese producer of needle coke from petroleum - is only producing at less than 50% of name plate capacity despite having the theoretical ability to produce a lot more.

    Meanwhile, the environmental picture in China has changed completely in the last two years - such that the requirements for bringing online new, extremely pollutive capacity (needle coke production from coal is really dirty) are only likely to delay new starts even further.

    Chinese exports displacing American/Japanese products once capacity comes online: as per above, I think the speed of new capacity will be far slower than you estimate (maybe 4-5yrs, and incremental, versus 1-2yrs and massive). Even so eventually new capacity will come, of course, as current economics are hugely incentivizing (at spot prices in China). Let's not confuse that, however, with contract prices overseas (half the price of the Chinese spot price today). In general, I am still quite skeptical that we automatically revert to the status quo from 2015, etc, mostly because European/global steel markets are no longer loose. Remember that GE costs are still not massively significant for EAF producers (1-2% of total product value). Why would European producers take risks on quality/yields for an extra saving of a couple thousand $/t on graphite (call it 30bps of the value of the end product) and risk the entire production process? Of course there is a linkage to global steel market conditions (likely the market will be much less juicy in 5yrs), so there will be some pricing pressure, admittedly. But I still think - having got used to higher quality, secure Graftech product, they will be loathe to switch to riskier product from new suppliers for a de minimis economic gain. 

    Take or pay contracts not binding on price: actually, of all your points mentioned I am most concerned about this. I had thought take or pay contracts were binding at the prices being reported; is this not the case? Perhaps I have missed instances in the past where these kinds of contracts were signed but then unable to enforce. If so, could you please direct me to some examples? thank you

     

    At the end of the day, I do agree that what happens in China will dictate the outcome here. But lets not confuse a correction in spot prices in China - from current levels $20k-30k/t - with a crash in the market globally. Recall also that even at EBITDA margins of $2k/t (versus $7k/t now), I think Graftech stock at IPO price is 10x EV/EBITDA - just the low end of the historical range. And how is dependence on China any different to any steel company globally? Average steelco multiples are 5-6x EV/EBITDA and 10x FCF or higher today, with lower margins, lower FCF, lower shareholder returns, no take or pay contracts, many not even in 1st quartile of the cost curve, and most without the vertical integration Graftech has. On that basis alone I think 6x FCF next year is the wrong price.

    appreciate all the discussion here - judging by the number of likes on Bismarck's post and the poor VIC score for this idea, it seems my view is a bit more anti-consensus than I thought :)


    SubjectRe: Re: Re: Re: Re: Some #s
    Entry04/13/2018 12:17 PM
    Memberpuppyeh

    katana - you are absolutely right and i tried to highlight in my writeup. needle coke usage for EVs is already 10% of total needle coke demand and growing, as you said, 30% per year in recent years. who knows if it continues at that pace but Graftech thinks it will be mid 20s % of the whole market in the early 2020s (ie by the time these contracts roll off) and so, like you said, you don't really need much of the secular EAF growth story to play out to see total demand growth in the 4-5% range CAGR range. 

    the bears would make the argument that China needle coke capacity will - apparently - grow 15-20% this year the next few years - something I clearly had a lot of problems with, as outlined in my previous comment. Meanwhile however the ex-China needle coke market is probably not really growing (or very low single digits) and the market is already at full utilization.

    again, I am willing to concede $20k-$30k/t pricing doesnt last - but the supply/demand picture outside of China is incredibly firm and likely to remain tight for the foreseeable future.


    SubjectBrookfield
    Entry04/16/2018 12:42 PM
    Memberblaueskobalt

    Hi puppyeh, thanks for the writeup and discussion.

    I was hoping you could discuss Brookfield's rationale for selling a bit more.  If the returns from here are so attractive, I don't see why they would be sellers after such a short period of time, even sitting on a 10x.  Harvesting billions of dollars of excess returns seems like good rationale to hold an investment; furthermore, I assume selling means they need to pay a big tax bill, and they have long/permanent-life, fee-generating vehicles that could hold this...


    SubjectQuality of chinese needle coke and GE
    Entry04/17/2018 10:39 AM
    Memberima

    Hi,

    this is a great thread. Plenty of thoughtful give and takes.

    I looked into the chinese market. the feedback i have so far is that the quality of needle coke is not good enough to produce UHP GEs. even if they come online, chinese GE makers will not be able to use them to displace imported needle coke, let alone make GEs and export them. this is a bullish conclusion if true.

    the barriers seems to be quality of raw material and know how when it comes to processing the raw material. Fangda has a JV with a japanese company and the japanese company does its best to limit the transfer of knowledge. Fangda does an ok job as a result but not on par with japanese. the rest of china is much worse. that said, i think the ROIC and $ profit of improving quality is so big that the chinese should put forward a much stronger effort than in the past. they have never had incentives like this before. Can they poach some japanese employees to improve know how? i think they can get their raw materials right, it will take some time to source.

     

    anyone have any thoughts?


    SubjectIPO price chatter & implication to valuation
    Entry04/17/2018 12:08 PM
    Memberbluewater12

    Assuming Graftech comes out at $18 (hearing it's at low end of range), how do you think about the valuation and the value to BBU itself? E.g., where do you think this is vs. expectations?


    SubjectRe: Brookfield
    Entry04/17/2018 04:54 PM
    Memberpuppyeh

    hi blaueskobalt - well, as i mentioned in the writeup, i don't really consider this a full sale - they are only selling 15% after all. even if they bailed out as fast as they could, given the likely liquidity of follow-on offerings and standard lock-up periods, Brookfield will be the principal owner for at least 2 more years if not longer. So I really don't think they are worried about the business hugely otherwise they would go for a trade sale. If they were selling the whole thing I'd think they would definitely wait another year and/or hold out for a higher multiple. of course, they clearly plan to exit at some point or in stages over the next few years and so this would provide the avenue to do so but in order to create a market for the stock you would need to leave some $$ on the table for investors.

    hope that helps.


    SubjectRe: Quality of chinese needle coke and GE
    Entry04/17/2018 05:01 PM
    Memberpuppyeh

    Ima - I tend to believe the Chinese graphite is of inferior quality for UHP electrodes, for many reasons, most of which I have discussed (difficulty of manufacture; quality of raw material; type of raw material). However of course they will eventually catch up (these are not memory chips we are talking about). The question is more about where prices go when they do (I guess, given all the worries on this thread).

    I think you need to recognize that spot prices in China are $25k/t right now. At those spreads of course we will see a lot of announced new capacity additions (although most will not come to market near term) but since I believe the ultimate incentive price needed to bring UHP GE production online is north of $10k/t, I don't consider a normalization to a lower level as a huge negative. If you ask any of the major graphite players (at least the Japanese, US, and Indian), none of them planned new capacity close to $10k/t; it is only since prices have lingered for so long in the $20-30k/t range that we are even seeing this discussion. if prices cratered back to where contract prices are, I believe you would similarly see a dearth of ongoing investment in the latter stages of many of these projects.

     


    SubjectRe: IPO price chatter & implication to valuation
    Entry04/17/2018 05:03 PM
    Memberpuppyeh

    I am a little surprised the response has been so tepid (I guess the rating of this idea on the board was a giveaway) but to me that isn't a bad sign at all; I would rather start off from skepticism and enjoy the re-rating than the other way around, so this could turn out to be a good setup. Clearly this is low versus expectations (and indeed my understanding of fair value) and so I would think BBU would sell as little as possible now.

    Of course it doesn't change my view of the mid-term for this company, and I think at $18 this is a good deal more attractive, basically 100% upside to a reasonable fair value in my base case.


    SubjectRe: Re: IPO price chatter & implication to valuation
    Entry04/19/2018 05:26 AM
    Memberpuppyeh

    just to update - this priced at $15, or around 4x FCF on my numbers next year. Suffice to say this is a crazy price, the market is essentially saying there is no value to the take-or-pay contracts because it is pricing the business as if it is a pure cyclical at peak earnings. I have heard some IPO feedback that some believe the prices embedded in those take-or-pay contracts may not be maintainable if push came to shove (Bismarck please clarify your contention here and how you came to this conclusion). Even if this were true I would still think this would trade at a better level (than say steel names or other commods who have no long-term price agreements) because of the cost position, position within the value chain, and ability to pay out huge cash returns. This price is not just cheaper, but a lot cheaper, than far inferior global players with worse positions on the cost curve and no long-term contracts. 

    I still think the stock is worth low-mid $30s and think this is an exceptional risk reward from this set up.


    SubjectRe: Re: Re: IPO price chatter & implication to valuation
    Entry04/19/2018 11:33 AM
    Memberbedrock346

    My memory of the old GTI is that it was a perenial value trap/dog. That some PE firm is selling it at 10x does not give one comfort. Maybe this time is different.


    SubjectRe: Re: Re: IPO price chatter & implication to valuation
    Entry04/19/2018 04:03 PM
    Membersancho

    ergh..no. You forgot that if those contracts are not enforceable and the electrode market loosens for whatever reason, the earnings power of this business gets cut by a crazy amount (70%? 80%?). All of the sudden what looks like 25% FCF yield would be like single-digit%. We don't of course know what the right answer is, because those long-term contracts have never existed before in this industry. Coincidentally, those contracts have been put in place right when the industry is at its tightest ever, and with a PE sponsor looking to monetize its stake. One shouldn't be suprised that people are skeptical about the contracts.


    SubjectRe: Re: Re: Re: IPO price chatter & implication to valuation
    Entry04/20/2018 03:21 AM
    Memberpuppyeh

    thanks for the additive hindsight comments. i didnt forget - i had a view that the industry is much less cyclical now than previously, for reasons i explained at length in the writeup and comments. i was clearly wrong on where this priced and the initial reaction, but luckily investing is a long-term game.

    let's touch base in a year and see where we stand with this one.


    Subjectupdate
    Entry05/15/2018 11:52 AM
    Memberpuppyeh

    this has been public 1month and has rallied 25% since IPO price. I am not taking a victory lap since I clearly thought it would price higher and that the IPO price was ridiculous. Since IPO, both EAF and its main competitors have reported very strong (but not exactly unexpected) 1Q numbers, and all three (EAF, Tokai Carbon, and Showa Denko) suggested extreme tightness in the market would remain for at least the next couple of years or longer. The sell-side has also started initiating on EAF, suggesting price-targets in the mid-20s (vs $18.8 current) which to my mind look still far too low.

    The main competitors - Tokai Carbon and Showa Denko - are not vertically integrated and do not have any security from long-term contracts; they are both structurally $2-3k/t higher on the cost curve, and will both not grow volumes (well, Showa will marginally) the next two years. Both names trade at 6-8x P/E next year, and 4-5x EV/EBITDA, and, I think, high single digit multiples of FCF despite parsimonious shareholder return programs. Today EAF trades at 5.5x P/E, 4.8x EV/EBITDA, and 5.4x P/FCF on 2019 numbers, will grow production and EPS aggressively the next two years, and - judging from comments on the call - will return a huge amount of excess cash in the medium term through buybacks or special divs (probably via direct buys from Brookfield as they sell down). These earnings numbers don't assume spot prices on the non-hedged portion of their production (around 30% next year), meaning you dont need current high prices to be maintained to see this kind of cash flow. 

    In absolute and relative terms, then, this still seems a great value. I think this name will eventually trade at least 9x FCF, and - since I think FCF will approximate net income in the next couple of years - this implies $30-$38 (on my 2019, 2020 numbers), or still a double from where we are today. 

    Next catalysts will be a) competitors' price negotiations for 2H'18 at levels much higher than where EAF has contracted, demonstrating demand strength; and b) clarification that St Mary's needle coke can be sourced, allowing for 2020 production growth to take place; and c) valuation pull through as we approach 2019 and people realize this thing is trading at 5x cash flow.


    SubjectRe: Re: update
    Entry05/17/2018 10:47 AM
    Memberpuppyeh

    thanks for the kind words katana - appreciated especially as this got a pretty low rating for what I thought was the best risk/reward I had seen in a long time. 

    agree with most of what you said about needle coke, though I didnt want to belabor the point as had spent a lot of time talking about their vertical integration being such a huge advantage. also agree with you in theory re St Mary's. one thing worth thinking/worrying about, though, is an alternate material being developed for EV instead of needle coke. Some companies are experimenting with silicon and silicon compounds instead, that - apparently - have up to 6x the conductivity properties of needle coke (and thus would be significantly cheaper on a per unit of power basis). One company, Ferroglobe, claims to be able to supply about 10k t of silicon compound by 2021 or so (though even at much higher intensity this would not cannibalize a large portion of the needle coke market, yet). The company is quite promotional and seems like there would be a long adoption period from customers before it even got to the point of replacing needle coke for EV batteries (the highest cost of failure use case), but it is certainly a threat to medium-term needle coke demand.

     


    Subjectpotential tariffs on Chinese production
    Entry07/18/2018 10:30 AM
    Memberpuppyeh

    apparently the US is considering additional 10% tariffs on graphite, uranium, and lithium, from China. since the major bear pushback against the maintenance of super-normal profits in the GE industry is a wave of new Chinese capacity, this news is extremely positive for the industry (if these tariffs go ahead). the market is already at full utilization, and contract prices in the US/Europe (maybe $12-15k/t at the moment) are lower than spot prices in China ($18-23k/t). so there isn't much sense for excess Chinese tons to exit the Chinese market, today.

    nevertheless, much like for steel, a further tariff on Chinese production would increase the value and sustainability of US (and Japan) based sources of GE production with an additional 10% implicit price power versus Chinese product that presumably eventually reaches quantities for export.

    this should be v good for EAF (as well as the Japanese/Indian manufacturers) if it goes ahead and needless to say I think EAF remains way too cheap.


    SubjectUpdate - good 2Q, buybacks begin
    Entry08/07/2018 05:20 AM
    Memberpuppyeh

    2Q earnings didn't really bring any new info. there is no change to the thesis - the market is still at max utilization and EAF is making 60%+ EBITDA margins despite selling at half of spot prices. The business has re-rated from 4x FCF to 6x FCF (on my 2019 numbers) but I still consider this far too cheap for a business of this quality.

    More importantly, Brookfield announced the first secondary offering - around $400mm, I think, of which about half ($225mm) will be bought by the company (ie 4% of the company in one go). This is exactly the playbook I expected, and think we see this repeated at least 3-4x over the next 1.5yrs or so. Brookfield will gradually exit, the free float will increase, but the number of shares out will come down aggressively (driving further EPS growth).

    Needless to say, I still think this is a mid-30s base case stock this time next year so despite the 50% return in 3mos since IPO, this is still a max conviction long


    SubjectAnodes
    Entry09/18/2018 10:36 AM
    Memberunbiasedobserver

    There are 318k metric tons of anode capacity globally. 225k tons are located in China. Almost the entire supply chain is located in Asia. Do Asian manufacturers source from Graftech, or they source from local suppliers? And given China's dominance, I think it might be deceptive for the company to use ex-China capacity in its filings. Thanks -


    SubjectRe: Anodes
    Entry09/18/2018 11:36 AM
    Memberpuppyeh

    there has been much discussion on this board as to whether chinese electrodes actually compete with Graftech's product (see comments 5, 10, 14, 17). As reiterated elsewhere, most all Chinese electrodes are not 'UHP' (ultra high performance), designed to withstand the higher temperatures and stresses that exist in electric arc furnaces; rather most chinese electrodes are of lower quality that heat ladle furnaces - a lower quality steelmaking furnace that contains much more pig iron and much less scrap. all the major UHP GE manufacturers - Graftech, Tokai, Showa - will tell you that the Chinese market really is something of its own animal and should not be lumped in with the global market for UHP. there is (valid) debate as to how fast and how much Chinese production will move up the quality curve to compete with the likes of Graftech in the coming years, but for now this point is also moot - because there is no raw material (needle coke) availability. this point has also been clearly delineated on this board and in katana's write-up.

    to answer your question directly - Graftech sells little or no product into the spot market in China; it has no long-term contracts with Chinese steelmakers today. if or when the Chinese steelmaking industry becomes more pure EAF heavy (highly likely as scrap availability increases), this may become a potential market. for now, Graftech's customers are most entirely in NA and Europe.


    SubjectRe: Re: Anodes
    Entry09/18/2018 11:59 AM
    Memberunbiasedobserver

    Thanks. But the quality issue is mostly about the electric arc furnaces - namely the steel market. I think Katana's thesis is more about anodes for EV applications. Presumably the quality requirements are quite different? There is an existing supply chain in Asia for EV applications (e.g.Jiangxi Zichen supplies CATL which supplies BYD). Correct me if I'm wrong - but based on my readings I don't get the sense that these anode makers import needle coke.  


    SubjectRe: Re: Re: Anodes
    Entry09/18/2018 12:01 PM
    Memberunbiasedobserver

    Let me phrase it another way - for EV applications, does Graftech compete with the Chinese at all? 


    SubjectRe: Re: Re: Re: Anodes
    Entry09/18/2018 12:18 PM
    Memberpuppyeh

    graftech does not sell, or export, any of its needle coke, either to China or elsewhere; it consumes it all internally (to make graphite electrodes). needle coke for EV anodes need to be sourced outside of Graftech's captive production (this is why everyone else is scrambling to secure needle coke and the price has gone up a lot).

    Katana's thesis is that demand for needle coke will be a lot larger than people think and keep the needle coke market tight for a long time; this will matter for all other GE makers except Graftech, because Graftech is (mostly) vertically integrated, and it is quite difficult to bring new needle coke production online quickly.

    i think you are getting a little confused between the needle coke market (key input to make graphite) and the graphite electrode market itself. 


    SubjectRe: Re: Re: Re: Re: Anodes
    Entry09/18/2018 12:41 PM
    Memberunbiasedobserver

    Thanks both for the reply. Yea I understand the difference between needle coke and grahite. Let me clarify my point - if the thesis is demand for EV application (anodes, which mostly uses synthetic graphite) will outpace the global supply of synthetic graphite and therefore drive up the price of needle coke - shouldn't we consider the capacity additions in China (that may dilute the surge in demand) although Graftech does not supply that market? I know the products don't compete directly with each other but Katana's argument is there will be price contagions across applications. 

    I was just back from a battery trade show - I got the sense that people are concerned about cobalt and to a much lesser extend lithium (both are only in cathodes), but I didn't get the sense that there is material shortgage on the anode side (maybe I am missing something).  


    Subjectupdate for 3Q earnings/CC
    Entry11/02/2018 11:25 AM
    Memberpuppyeh

    EAF reported strong earnings but the stock is now -10% after some rather cryptic comments on the call. One of the big issues for EAF is whether or not they would be able to restart one of their mothballed facilities, St Mary's, using 3rd party needle coke, in 2020. Last Q they suggested they were 'optimistic' re being able to procure enough 3rd party needle coke from Philips 66 (around 30k tons) to restart, but that nothing had been concluded yet. Now, they are saying a combination of 'its too early to talk about St Mary's' and 'we want to take the environment the market gives us' which is being interpreted negatively - the implication being that the market is already rebalancing (suggesting other capacity creep, or some imports from China perhaps displacing UHP electrodes in the US).

    On the other hand, the implication could simply be that there is not enough 3rd party needle coke available - and thus that GE prices need to stay where they are ($13-14k) or go higher. Indeed they mentioned needle coke prices are now around $4.5k/t (higher than $3.5k/t last Q) meaning needle coke prices are still going up; this jives with what we have heard from the major needle coke producers (P66, Mit Chem, etc) who all suggested limited or no large-scale capacity expansion near-term so for now I am still leaning towards 'this management team are poor communicators' rather than 'demand for GE just died.'

    While management's performance on the call wasnt great, and they were a bit mealy-mouthed, I think the risk for EAF from here is relatively limited. Either they restart St-Marys at reasonable margins and grow earnings/revs through volumes; or they don't, but spot prices stay or go higher on their current production (which is still mostly struck well below market at <$10k/t vs spot at $13-14k/t). Either way they should do fine and I still think they can do near $4 in EPS in 2019/2020 (without much contribution from St Mary's) meaning this is at <5x P/E and FCF...so not like St Mary's is being price in in any case.


    SubjectRe: update for 3Q earnings/CC
    Entry11/02/2018 11:39 AM
    Memberjso1123

    They mentioned spot needle coke prices and historically they've always mentioned spot GE prices - but this call they said they couldn't comment on them (not enough data or something along those lines).  Do you have a sense of why they wouldn't answer?  In prior calls I believe they did

     


    SubjectRe: Re: update for 3Q earnings/CC
    Entry11/02/2018 12:04 PM
    Memberpuppyeh

    jso, i tend to think this is a very JV management team (at least the CEO gave that impression today, it was not a good performance). the excuse mentioned was that they had next to no spot sales in the Q, so they don't really know where spot GE prices closed. that does sound disingenous, but since we have reasonable clarity of where spot prices are (from other manufacturers), there was nothing really to be gained from pretending they didn't know where spot was. it is confusing.

     


    SubjectMy take on the earnings call
    Entry11/05/2018 10:31 PM
    Memberhelopilot

    I think the call went poorly and given how management answered various questions.   There are three things that raised flags for me:

    1) They were evasive on GE spot pricing (already mentioned)

    2) They changed their tune on St. Mary's restart - as puppyey said, "'we want to take the environment the market gives us"

    3) They went out of their way to not comment on PSX needle coke supply

    I have a theory on what happened - this is purely me speculating...

    - EAF was in discussions with PSX for a needle coke supply contract, and EAF was looking for a 5yr term term that was well below the $4,500 spot price of Needle Coke (eg. $3k / ton).  PSX said no way, needle coke supply will only get tighter because only a handful of us can make it, blah, blah, blah

    - A spot player (eg. Showa Denko,) rolls into PSX and says, we will pay full spot at $4,500 for all your extra needle coke, and we won't demand a multi-year supply deal.  PSX says sold to highest bidder

    - Showa Denko (or whoever) is gonna use to the extra needle coke to de-bottleneck existing capacity and now has a step function increase in GE volumes to sell.  So they begin to hit up the 2019 spot market with volumes.  This weighs on spot pricing.  

    So bottomline, St. Marys restart aint happening in 2019, spot pricing likely coming down because someone else is going to fill St. Mary's void with spot sales (and not take-or-pay contracts).  Instead of EAF coming clean with all of this on the call, they pretended nothing had happened as Brookfield is about to drop more stock.  


    SubjectRe: My take on the earnings call
    Entry11/06/2018 01:16 AM
    Memberpuppyeh

    helopilot - thanks for sharing an interesting theory. a couple of pushbacks:

    - not sure P66 would be so eager to say no to a long-term contract at $3k or so vs spot sales at $4.5k. Last I heard needle coke prices were actually $3.5-4k (before this Graftech comment) and they were clearly $500/t a yr ago right...so just like EAF is happy to take $10k/t on l-t contracts, pretty sure P66 would lock in $3k/t on needle coke long-term if someone offered it to them

    - even if the entire scenario is true - we are talking about 28kt of graphite (the assumed St Mary's 'void' as you call it) that is low single digits of annual consumption into a market that is still v tight...why exactly would that cause spot prices to crater?

    Alternative explanation:

    1) this management team are terrible communicators

    2) they are mid-negotiation with P66 on both St Mary's and other needle coke supplies and wanted to say as little as possible (even if this was executed poorly)

     

    Let's see if Brookfield actually sells more stock at a lower level than the last print ($20 I think). If they do, I might be more inclined to believe some of the scenario you paint, but this hasn't happened yet. Personally I don't think Brookfield will dump stock lower than last print.


    SubjectRe: Re: Re: My take on the earnings call
    Entry11/06/2018 08:06 AM
    Memberpuppyeh

    hey katana - i think that actually supports my point: he gave the impression demand is part of the issue, even though in reality it is all about needle coke supply. i think he is trying to signal to his needle coke suppliers (ie P66) something that actually isnt true because he wants to negotiate the best possible price for needle coke (both St Mary's and non-St Mary's). we know demand is not the issue because of all the things we have discussed many times herein (and of course the same message from competitors that the market is still at max utilization and unlikely to ease near-term). i mean, this is why his wishy-washiness was so surprising to the street...so i do think this was a poorly-communicated negotiating tactic, we will have to see if it works  (in terms of getting him his needle coke supply at prices he thought were realistic 6mos ago).


    Subjectspecial div
    Entry11/27/2018 04:10 PM
    Memberpuppyeh

    EAF will pay out a near 5% special div (basically the bulk of last Qs FCF). in other words the co will have returned nigh on 10% of the market cap in the 7mos or so since returning to public markets - not bad at all and a faster pace than I was imagining. the fact they are doing a special div and not another buyback tells you, I think, that Brookfield is not interested in selling the stock anywhere near the current quote. i for one think that is a good sign (not that the market cares for now thought).


    SubjectRe: Re: special div
    Entry11/28/2018 05:40 AM
    Memberpuppyeh

    right there with you katana, but at this rate i think me and you will be the last ones left owning this, sitting in a room crying into our beers (while Brookfield looks on and laughs)...


    Subjectupdate
    Entry01/09/2019 03:58 AM
    Memberpuppyeh

    prices of most all other commodities have been going down on macro/China weakness, etc, but news out the other day confirms graphite prices are still very firm (at the contract level). One of the Japanese players (Tokai Carbon) has - according to the Japanese press - secured pricing of $14k/t for 1H 2019, along with needle coke in the $4-4.5k/t range (ie similar to what EAF said last earnings report) - in other words for GE players selling on the spot market, spreads are still increasing (despite the correction in steel prices we have seen of late). 

    Tokai Carbon is the no 3 player in the US market. If their customers (not just Japanese steel mills) are still willing and able to pay $14k/t, I find it hard to believe EAF (the no 1 player in the US) cannot at least sustain the contracts they have signed at <$10k/t. Moreover, the demand outlook in the US - EAF's core market - has significantly changed since I wrote this up, as all the major players have announced capacity expansions that will increase underlying demand for GE by around 15% in aggregate over the next few years. Clearly steelmakers would not be announcing these purported investments unless they thought they could generate sustainably attractive returns even with market status quo conditions (again, in which GE even at current prices are still only ~2% of the cost of finished HRC).

    macro sensitivity/China blowup risk aside, I still consider this a wildly undervalued stock (at 4x largely contracted 2019E FCF).


    SubjectRe: update
    Entry01/17/2019 07:42 PM
    MemberBismarck

    Indian UHP prices are down 10-13% QoQ. It's possible that this is temporary destocking (because 2018 was a re-stocking year) but highly doubt it. If Indian players don't get the right price from domestic steel makers, they will export to international markets, thereby driving down international prices. 

    Also, a lot of steel players have worked very hard over the course of 2018 to source Chinese UHPs. Whether Chinese UHPs can be used for non-Chinese EAFs is not a black and white answer. Some plants can use them, some plants can't. Procurement guys all over the world are working hard to find decent quality, cheaper UHPs. Chinese exports are going to be up 20-30% again in 2019.

    The bull case here also HAS TO assume demand holds up (because the 1/3 of volumes requires some bullish price and spread assumptions). As we saw in India, the moment that doesn't happen, GE prices face pressure. Not a macro expert but i'm willing to take the under that demand holds up over the next few years.

     


    SubjectRe: Re: update
    Entry01/17/2019 07:46 PM
    MemberBismarck

    Also the points about special dividend etc misses the point. If you add contracted cash flow + 5 years of bullish price assumptions and a normalized terminal value, you can't get to $20+. A special dividend pulls forward the cash return (and obviously hurts the shorts in the short term) but it does not change the fundamental value of the business. This is why at the right price, this can be a very attractive long-term short if you have a PM that allows you to ride out the inevitable large moves in the stock.


    SubjectRe: Re: Re: update
    Entry01/18/2019 07:54 AM
    Memberpuppyeh

    would you care to share your math on that valuation methodology? it all depends what your view of normalized earnings power is, of course - you can clearly get less than $20 if you think normalized EBITDA margins are single digit, but that goes to the heart of whether you think the business has structurally improved, or not. of course that is the million $$ question...

    Indian UHP prices - if this price decline was so meaningful, why is Tokai Carbon able to achieve price hikes across all their customers at the same time? I disagree that Indian production can truly compete with international (Japanese/US) product. Tokai Carbon supplies US, European, and Japanese premium EAF steelmakers; the Indians (and the Chinese) presumably try to sell their UHP product to them too (in fact I just came back from a plant tour of Tokai Carbon's Hofu plant). they still say the cost of using a lower quality product - in the vast majority of high-value EAF furnaces - in terms of electrode breakage or leakage far outweights the incremental cost advantage of a few thousand $/t (recall total electrode costs are still only 3% or so of finished product).

    you may well be right that the Indian/Chinese catch up, of course they will eventually - but this is a process that likely takes many more years and the stock is at 3.5x earnings. it took Posco over 10yrs to penetrate Toyota as a Tier 1 supplier for steel, for example, and they are a far superior producer of scale in their relevant product than many of the johnny-come-lately electrode producers in India and China.

    personally i am MUCH more worried about demand rolling and what happens thereafter if/when that happens (though I still think the contracts are money good). however you can easily hedge this specific risk using China/steel-exposed names that trade at much, much higher multiples of FCF today, than EAF, for example (I have a couple of these trades on).


    SubjectRe: 34k tons of new LT contracts entered at a 20% higher price
    Entry02/11/2019 09:39 AM
    Memberpuppyeh

    thanks katana. just a couple of quick hits post the Q4 call:

    - the tone is definitely changing and management (to me) is clearly presaging a lower price environment in the future. at the same time they are doing all the right things (locking in more volumes under LTAs, and accelerating debt paydown) and of course the stock has come off a lot as well so I still think this is materially mispriced.

    - the willingness of customers to enter incremental LTAs at much higher levels to me pretty clearly kills the bear argument re these contracts - even at $9500/t or $10k/t - being likely to break. That argument is simply not credible if customers are a) willing to lock in more long-term volumes at higher prices; and b) conducting greenfield EAF expansion of their own in the current GE price environment (cf Nucor, AK steel, STLD, etc).

    - management indicated clearly for the first time since relisting that greenfield costs for new GE plants are at least $10k/t, and more like $11/12k/t. Taking this at face value, replacement cost of the operational assets (say 203k pa of GE production) is around $2.2bn (using $11k/t); to which we should add St Mary's (incremental say 25kt at $10k/t to allow for remedial restart costs of arounf $1k/t = $250mm), ie the GE assets alone are worth around $2.45bn. To this we add $380mm of positive NWC, and replacement cost for Seadrift needle coke - which, at 125kt pa, I put at ~$2k/t, ie $250mm (bit of a moot point at the moment but just for discussion). Add it all up you get around $2.7bn in replacement value, including NWC - though note the assets themselves would take multiple years to construct so on a grossed up basis I fairly comfortable this number is really more like $3bn.

    - The present value of the contracted FCF remaining is around $1.9bn (using contracted volumes out to 2022, conservative costs for Seadrift needle coke, and an 8% DR on the FCFs). Since the EV of the company is $5.8bn today, this means you are paying $800mm for the non-contracted volumes as well as whatever the business looks like post 2022. Even at much lower earnings power on the non-contracted volumes - say $2.5k/t - and a comp multiple (4x ref Showa Denko, Tokai Carbon), that already justifies the current price of the stock. Realistically I think the terminal multiple, as well as earnings power, should be a lot higher than this but highlights the margin of safety at current valuations.

    - In reality I expect Graftech to continually chip away at excess available volumes in 2021-22 (and clearly later years if possible) to reduce risk even further.

    - Perhaps the most reasonable bear pushback coming out of the call is that the massive capital return story in 2019/2020 is less likely now as they will prioritize debt paydown sooner rather than later. I still see in excess of a 10% TSR this year, admittedly this is much lower than estimated in earlier in the original writeup.


    SubjectRe: Re: Why the secondary?
    Entry03/06/2019 03:45 PM
    Memberpuppyeh

    i wish i was as neutral on this as katana. honestly i have been doing a fair amount of soul-searching on how this investment has played out, and this last selldown by Brookfield has got me, not quite, but almost, ready to throw in the towel (it is simply too cheap here on any level to sell, to me). i agree with katana in the sense that there may be other motivations for the selldown this far below the IPO price, and it may mean nothing - but also I did not think brookfield would sell down at a price this low...and i also cant see how the stock can really do anything now given the amount of stock they still have to sell into a market that clearly knows they are basically a seller at any price (if they're willing to dump at 3.5x FCF then why not lower?).

    so yes, this has been very frustrating for me and has got me really questioning how I think about deep cyclicals. reading back my original pitch/thesis - I honestly don't think too much of it has been wrong in terms of the fundamentals (absent the St Mary's restart, but that was always a bit of a question mark). but the market' perception of the quality of the cashflows - and a lack of understanding of the motivations of the key stockholder - were clearly way off and contributed substantially to the negative PnL thus far.


    SubjectRe: Re: Re: Re: Why the secondary?
    Entry03/06/2019 04:28 PM
    Memberpuppyeh

    you're right i was extrapolating from my own melancholia - you were speaking specifically about Brookfield's actions, and I think you're right, there's a non-zero chance the sale doesn't go aheas down here. or if it does, the company really needs to send a signal and buyback some of the offering (even if just $100mm) given they paid, what, $19 last time around quite happily?

    going back to your thesis katana - much of your writeup posited that 'this kind of stock' was deeply unloved by the market at the moment and that this potentially would change. clearly that hasn't happened wrt EAF but I wonder if you think the growth/value disconnect is not now even bigger than when you said that (look at other prototypical value/cyclical stocks, there are certainly tons in my book, all have really underperformed since Powell backflipped essentially)...it really is incredibly frustrating and patience-testing :(

     


    Subjectquick update post 2Q
    Entry07/31/2019 04:00 PM
    Memberpuppyeh

    2Q results were fine, really nothing to say. Third party needle coke keeps going up - this is not news, all the other players have been suffering - and while EAF saw a slight drag in their pnl as a result, essentially this reinforces the uniqueness of their positioning and value of vertical integration. the call made clear (to me) that needle coke will remain high, or go higher - meaning EAF's competitive positioning is getting better and better.

    there were a few slightly disconcerting comments re inventory build and slightly lower utilization (90% for the yr vs mid-90s beforehand), which mgmt seemed OK to signal was because they don't want to push too much out into the spot market. Not great, but again, not really news (Tokai carbon was already cutting production).

    the BIG news was the buyback and commentary/signalling around that. instead of buying back a chunk from brookfield (as they did last time), they are just going to buyback $100mm in the market (15% of the float today). they also said they would return 50-60% of total FCF this yr to shareholders (no change there) but if 2H FCF is $350mm or so and they do another $100mm of debt reduction, less divs, I could see them easily funding another $100mm++ of buybacks in the mkt from 2H FCF as well.

    while this is a good deal lower than the amount of cash I thought would come back pre-IPO, the key point is the manner in which the cash is coming back (reducing free float 30%+ or so if it happens) rather than taking Brookfield out...the corollary being I think the likelihood Brookfield shops this or takes it private again (probably around IPO price if the stock doesnt perform) is, I think, really increasing. to me - this, plus the technical support from executing this kind of buyback, is a solid new impetus for the stock (still at 4x earnings, by the way).

     

    i added to my position this morning.

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