Graftech International Ltd.

Company Overview: Graftech International Ltd. (NYSE: EAF) is engaged in manufacturing graphite electrode products to cater to electric arc furnace steel (EAFS) producers. EAF has vertically integrated the graphite electrode manufacturing with petroleum coke needle production, a primary raw material for graphite electrodes and a high demand product for lithium-ion battery manufacturing.

EAF Details

Material Business Updates

• EAF Expands Operations in the Japanese Market: On 26 July 2021, EAF announced a new sales office in Japan to cater to regional clients with local customer service, commercial assistance and technical support. EAF has been in business with the Japanese market for over 25 years.
• Commercials of Secondary Offering by Existing Shareholder: On 24 May 2021, EAF announced the intent of current shareholders – Brookfield Asset Management Inc. and Brookfield Business Partners LP – to relinquish 20 million shares via a secondary offering at a negotiated or market price. JP Morgan Securities LLC acted as the sole underwriter of the secondary offer.

Historical Financial Trend:

EAF illustrated sustainable historical growth while keeping the value proposition intact. The Operating revenues have been growing since FY16, with temporary hurdles in FY20. As a result, operating revenues grew at a 29.3% CAGR (FY16 – FY20).

Figure 1: Historical Financial Overview

Source: Analysis by Kalkine Group

First Quarter FY21 Performance:

• Financials Abstract: Although the top-line assumed a marginal erosion of 4% in Q1FY21, EAF reported a 9% PcP increase in sales and production volume. Subsequent to a 12% PcP decline in gross profits, adjusted EBITDA declined by 13% PcP with a non-material impact on margins.
• Global Quarterly Trend: Excluding China’s figures, global steel production and the global steel manufacturing utilization rate have warranted a 3% sequential growth and ~1 percentage point uptick, respectively.

Figure 2: Quarterly Performance

Source: Company Reports, Analysis by Kalkine Group

Full-Year FY20 Performance:

During FY20, sales volume significantly declined by 21%, leading to significant top-line erosion. However, EAF proactively managed operations during the pandemic period and approached the recovery phase in late 2020. Due to a prudent management system in place, EAF avoided significant potential declines in operating margins.

Figure 3: Annual Performance

Source: Company Reports, Analysis by Kalkine Group

Top 10 Shareholders:

The top 10 shareholders together form ~48.10% of the total shareholding. Brookfield Asset Management, Inc. and The Vanguard Group, Inc. holds a maximum stake in the company at ~24.30% and ~5.97%, respectively.

Figure 4: Top 10 Shareholders

Source: Analysis by Kalkine Group

Key Metrics:

Exceptional growth in revenues post FY17, primarily attributed to a significant uptick in weighted average realized price and build-up of long-term contracts, has translated into potential stability in the top-line. In addition, the steady margins and proliferated global steel production exhibit a sustainable operating cycle.

Figure 5: Key Financial Metrics

Source: Analysis by Kalkine Group

Outlook:

• EAFS Industry Prospects: As per World Steel Association, the EAF industry has widened by 6.4% CAGR since 2015. This is because EAFS has come out as a cost-effective and environmentally safe method of steel manufacturing.
• Rising Opportunity of Diversification into Battery Industry: With the exponentially growing demand for electric vehicles, EAF is exploring opportunities to extend petroleum needle coke production for lithium-ion battery manufacturers.
• Opportunity in China: According to recent updates, EAFS production is expected to constitute 20% production in the steel industry by 2025. This has amplified EAF’s intention to encroach further markets in China’s steel industry.
• Restructuring Contract Agreements: EAF has extensively engaged in Long-Term Agreements (LTAs) characterized by take-or-pay contracts with price and volume certainty. This shall incorporate stability in EAF’s top-line growth.

Figure 6: Volume and Revenue Guidance

Source: Company Reports, Analysis by Kalkine Group

Key Risks and Challenges

With a rising inclination of the steel industry towards the EAFS production method, market competition for graphite electrodes has significantly increased. The industry operates in a prolonged cash conversion cycle; therefore, non-LTA revenues may face cash flow and price uncertainty.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Stock Recommendation:

Stock Recommendation: EAF has delivered 3-month and 6-month returns of ~-11.594% and ~+3.879%, respectively. The stock is trading above the average of the 52-week high price of US$14.16 and the 52-week low price of US$5.87, indicating an opportunity. We have valued the stock using the EV/Sales multiple-based illustrative relative valuation method and have arrived at a target price of low double digit-upside. We believe that the stock might trade at a slight discount compared to its peer average EV/Sales (NTM trading multiple), considering high competition and potential cash flow instability. For this purpose, we have taken peers such as Emerson Electric Co (NYSE: EMR), Hubbell Inc (NYSE: HUBB), American Superconductor Corp (NASDAQ: AMSC), to name a few. Considering the opportunities in the Chinese steel industry, growing production of lithium-ion batteries, and valuation, we give a “Buy” recommendation on the stock at the current market price of US$10.98, up by ~3.2% on 26 July 2021.

EAF Daily Technical Chart (Source: REFINITIV) , Note: The purple color line reflects RSI (14-Period)

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

Disclaimer

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