Graftech (EAF) - Time To Move On
For those that follow me on Twitter(X), you’ll know Graftech(EAF) has been a portfolio position for ~3 years and has struggled almost the entire time.
Q2 results (7/26/2024) had basement-level expectations. The results had some puts and takes, but overall, they were better than I expected. However, the conference call was not good, specifically management commentary and tone surrounding 2H 24 into 2025.
Sales of $137.3m (-26% y/y, +0.5% q/q) stemmed from 25.5k tons sold. Mix: Spot - 22.7k (+13.5% q/q) at $4,300/ton (-2.3% q/q), LTA 2.8k (-31% q/q) at $8,300/ton. Costs/Ton of $5,2000 declined 16.2% y/y and 6.8% q/q. This needs to continue to trend downward, as current spot prices of $4,300 would result in negative gross margins excluding LTAs. SG&A came in at $5.1m (-72.5% y/y, -66.6% q/q) due to a one-time lawsuit settlement.
FCF of -$44 was the main negative stemming from cash used in working capital. Q/Q rate of change spot pricing improved – from -11.1% in Q4 23 to -8.3% in Q1 to -2.3% in Q2. This suggests we are nearing a bottom in spot pricing; however, on the call, management said pricing remains soft. Exports from India/China to the Middle East continue to pressure pricing. On top of this, cash costs are expected to increase due to plant shutdown time and higher energy prices, which likely means break-even gross profit in Q3 (at best).
Building up pin inventory – signals they are probably going to idle capacity somewhere, might be Mexico. NA steel production -5% y/y. EU Steel output +3%.
By the end of the decade, 170m of new EAF capacity could bring 200k tons of incremental GE demand. What does Graftech look like by the time this occurs…?
KEY POINT – Volume negotiations for 2025 will begin at the end of Q3 and the beginning of Q4. Given current pricing trends, based on management commentary, pricing for 2025 electrodes, which they will lock in around 50% of volumes, is going to come in around $4,300-$4,700/mt. Even after the cost reduction programs, their manufacturing costs (including depreciation) are higher than this, in the high $ 4,000/mt ($4,900 or so) at current utilization rates. Layer in $60m of SG&A and $60m of interest expense, and they are quickly out of money, barring a rebound in pricing. They will burn in the neighborhood of $50m in 2H 24, putting YE cash around $70m. Steel production utilizing BoF is cheaper. With steel prices down 21% in the year, steel producers will run their cheapest option, Blast Oxygen Furnaces (one reason why met coal has held up well). While management does not believe they will need access to capital in 2024, I think they will in 2025.
Closing Thoughts—Seadrift, thought to be a key competitive advantage, is a drag due to excess costs. Electric Vehicle sales have fallen off a cliff, lowering the demand for Needle Coke. China’s property slowdown is creating excess GE supply, which is being exported to other countries. The buybacks and BAM bonus paid not so long ago are something they certainly would like back.
We decided to exit our position in Graftech. I don’t see a probable path for Graftech to get through the down cycle without raising capital. A key tenant of the thesis centered around low-cost production due to the vertical integration with Seadrift. While this thesis may hold up when demand for EVs and, therefore, the need for Coke recovers, during this market downturn, where seemingly everything negative is occurring all at once, it is disproven.