Introduction
I recently became interested at Graftech International ltd. (NYSE:EAF) after reading a June 2019 Mohnish Pabrai (Trades, Portfolio) interview, where he anticipated that he was going ought commit a great chunk of his assets ought a company he used to no uncover during they were calm at the process of buying it, but, he added, anyone who was interested could simply restrain the 13F, which they were going ought uncover at August. during I was reading the composition at September, I presently rushed ought the Securities and Exchange Commission's website and discovered the assign (Dalal Street, his investment vehicle, had a whopping 27% of its funds invested at Graftech can the aim of the third quarter).
To exist honest, it was no the first time I had heard of Graftech. Indeed, a dear acquaintance of mine picked it from Joel Greenblatt (Trades, Portfolio)'s magic formula website (as of writing, Graftech is calm can the list).
Graftech is involved at the product of UHP (ultra-high-performance) Graphite electrodes, used ought efficiently invent steel at electrical arc furnaces with a cheap environmental impact. The electrodes are capable ought backward an extremely high voltage, which is a key separate of the steel product process. The chief raw material needed ought invent the electrodes is called needle coke (which at change is produced starting from byproducts of grease refining).
Graftech's predictable revenue stream
Here is Pabrai's investment thesis: the company has three- ought five-year take-or-pay contracts at lay with a diversified lay of customers, which covers a great separate of his median fare (around $12). accordingly whatever is going ought venture while the contracts die represents a low-risk scenario during you're going ought acquire the sum company because around nothing.
Here is the above-mentioned harmony revenue breakdown (from the latest 10-Q):
As you can see, most of them die by the aim of 2022 and permit because more than $1 billion of revenue per year (and around $700 million ought $750 million at liberate coin flow).
This implies an high type of predictability (even if a guest refuses ought buy the planned fixed volume of Graphite electrodes, the penalties used to practically constrain them ought allowance around 100% of the salary anyway).
A firm moat
Another same significant confront of Graftech is the fact it is the only vertically-integrated Graphite electrodes producer. Indeed, one of its subsidiaries, Seadrift, produces 70% ought 80% of the entire number of needle coke needed by the company at production, can a fare that is manner lower than the contemporary median fare of the industry. This basically route the company has an unparalleled control can raw material prices: indeed, needle coke costs invent the bulk of input costs because a Graphite electrodes producer. because the remaining 20% ought 30%, Graftech is forced ought buy the needle coke can the site market.
For a company operating at the steel sector, the structural supicion of raw material and final products prices, combined with the fact that the industry is typically cyclical, is one of the most difficult headwinds because investors trying ought chart out its future prospects, calm here we dine a company which was capable ought (almost) patch one of the two variables, making future assumptions easier and, more importantly, chief ought a great competitive utilize can its competitors, which are fully prone ought the swings of needle coke site market.
Moreover, needle coke supply is going ought exist beneath strain at the coming years during it is too a key element at lithium ion batteries, which are currently at same high lack from electrical vehicle producers.
But what happens while the salary of needle coke increases? too the electrode producers pass the fare can ought their customers or, if electrodes prices don?t change, utilize margins because Graftech competitors will contract and, can some point, they will exist forced ought lessen or defer production. This, at turn, will lessen the supply of Graphite electrodes. can that point, the only manner a guest is going ought earn access ought them is paying a higher price. accordingly I desire that Graftech will exist capable ought earn some more take-or-pay contracts can good prices with customers who anticipate ought safeguard themselves from the inevitable (of course, Graftech only sells can fixed price-volume the product separate that is linked ought its available low-cost needle coke resources).
Graftech has too built, can the years, an expertise at high-quality needle coke production. Currently there are only three other companies at the dirt that can invent it with the same characteristics (the biggest of which is Phillips66 (NYSE:PSX)), and it can accept little years ago any company can build such a high-tech facility, accordingly this can too exist considered an advantage, even if no a eternal one.
Uncertainty and risk
The puzzle is: why is the just voluntary ought assign such a depressed salary ought Graftech? Because, during it always happens at these cyclical industries, it's confusing supicion with risk.
Here are the chief reasons:
It is evident that the cause of this novel cannot exist accurately predicted by one only scenario; there are simply also many variables ought consider. calm what can exist said is that there are no accordingly many ways Graftech can fail during of its structural advantages, moat, highly proficient employees and just oligopoly status.
Conclusion
Even if it is difficult ought assign a exact appraise ought Graftech (which lies at the $20 ought $30 per fraction range) during of the high supicion related ought the steel sector, the scenarios which can materialize at the next two ought three years are entire acceptable.
I growl on the buy of the company shares can contemporary prices during a low-risk proposition with a gay border of safety. at Pabrai?s words, this is a "heads, I win; tails, I don't lose much" friendly of company. during a groan of high faith at its prospects, at December, the company bought backward $250 million worth of stock from Brookfield Asset Managment (NYSE:BAM) (the contemporary majority shareholder).
For investors who dine the patience ought wait because the just ought "destock" and recover more ordinary supply and lack levels, and because the needle coke salary pressures ought kick in, the rewards could exist huge. Time will tell.
Disclosure: The author owns shares of Graftech International.
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This composition first appeared can GuruFocus.
