Ergin Yalcin
Although GrafTech International Ltd. (NYSE:EAF) has been facing some strong headwinds since November 1, 2021, the company has in fact struggled in regards to it share price since the end of July 2018, when it was trading at approximately $24 per share.
From there it plunged to a little under $6.00 per share, and after a triple bottom, started an upward run in mid-September 2020, jumping to approximately $14 per share in mid-May 2021, before reversing direction and starting a prolonged downward trend that continues to this day.
If the situation at its Monterrey, Mexico facility is not resolved in the near future, the company faces a drop in sales volume of at least 50 percent, according to CEO Marcel Kessler in its earnings report.
That’s significant, not only because it represents 30 percent of total annual production for EAF, but it’s also the only site the company has that produces pin stock that is used in its electrodes.
In this article we’ll look at some of its recent earnings numbers, implications of Monterrey, and the softening steel market that will cause a drag on the company’s performance.
Latest numbers
Net income in the third quarter was $93 million, with EPS of $0.36.
Adjusted EBITDA was $129 million, a decline of 25 percent from the third quarter of 2021. Adjusted EBITDA margin was 42 percent in the reporting period.
The reason for the drop in adjusted EBITDA in the quarter was from inflation associated with energy, freight and some raw materials. On COGS per metric ton, the company expects the fourth quarter will have the same 5 percent increase as the third quarter.
Another potential cost headwind for 2023 is if Monterrey doesn’t reopen in the near future, which would increase costs in order to restart its facility in St. Marys, Pennsylvania to supply its pin requirements. The St. Marys facility was formerly used to produce pins. Outside of that, the company said it was pursuing other solutions to its pin issue, including producing pins at European facilities as well as acquiring stock from third parties.
Also, if Monterrey doesn’t reopen, the company will have to eat some fixed costs in response to the expected decline in revenue.
Cash flow in the quarter was $68 million from operations and $52 million of adjusted free cash flow. Both of those numbers were down from third quarter 2021’s numbers because of the decline in net income and higher working capital.
In order to retain more liquidity, the company decided not to make a voluntary prepayment on a term loan.
Liquidity in the third quarter was close to $435 million, with $109 million of that cash on hand and the remaining $326 million available under its revolving credit facility.
Management stated it believes is has enough liquidity to deal with the challenges the company faces. My view there is that’s probably the best-case scenario in light of the enormous headwinds the company faces.
As for CapEx, expectations are it will remain the range of $70 million to $80 million, although it will, in part, be allocated to different priorities than originally intended, especially in regard to solving its pin stock problem.
Global markets softening
To add to the challenges faces from Monterrey and inflation impact on the company, the global steel industry has been softening in the third quarter, with global steel production at $198 million tons, down 9 percent from the third quarter of 2021.
Consequently, global capacity utilization rates were down 64 percent as a result of lower production. Management said that data points in the quarter mean it’s the lowest utilization levels over the last 8 quarters on a global basis.
Economic weakness in Europe is also having a negative impact on the steel industry there, partially from the war between Russia and Ukraine.
Even though the U.S. market is healthier in comparison to other markets, utilization rates there are also starting to soften.
Impact of softening market
There’s one positive to take away from the softening global steel market, and that is with current inventories – even with a 50 percent decline in the electrode market representing about an 80,000-ton annual rate – it has lowered demand to the point it probably won’t have near the effect it otherwise would have had in general. It would start to have a significant impact in the second half of 2023.
As it relates to EAF, after selling about 36,000 metric tons of graphite electrodes in the quarter, which was down by 18 percent year-over-year, it could provide some breathing room as far as extending some it has to find a supply of pins.
Yet, even under that scenario companies may not want to deplete pin stock inventories to the point it could cause shortages. They’ll do that if they have to, but I think they’re still going to look for alternative pin sources to mitigate the possibility EAF takes longer than expected to become a reliable pin supplier to the market.
At best the softening market may buy the company a little time, but not enough to make a significant difference in its performance over the next couple of quarters, unless Monterrey quickly reopens.
Conclusion
There is no doubt EAF is going to struggle to turn things around anytime soon, having been hit by a perfect storm of negative events and circumstances that have staggered the company.
The best-case scenario is for Monterrey to reopen in a relatively short time. That would obviously answer its pin stock problem and the higher costs associated with finding alternative sources to supply the company.
Add to that a weakening steel sector and a weakening economic environment, and it’s difficult to see how the company is going to find a way to turn things around in the near term. Even if Monterrey was still operational, the company would have been under pressure from the slowdown in steel.
Looking ahead, unless there is a quick reopening of Monterrey, the company is going to struggle for the next couple of quarters at least, and after that, depending on the economy, steel demand and inflation in the second half of 2023, it could be a long time before the share price of EAF starts to sustainably improve in my opinion.
The only play on EAF in the short term that I see is to look for another significant hit to its share price if little changes in its current circumstances and take a position on an attractive entry point. That would be for investors with a long-term investing horizon.
In the short term the stock is likely to remain volatile based upon its vulnerability to the news cycle with the current headwinds it faces. In that scenario it would be a good day trade or swing trade.
Even with its drop in share price since the latter part of 2021, it could go down a lot further before it finds a bottom if it takes longer than expected for the headwinds to be resolved.
So, whether a long-term play or a quick play to get in and out of the stock with a quick profit, EAF is a high risk holding.
Be the first to comment