GrafTech International (EAF - $11.62 – NYSE) (EAF, Financial) is one of the leading producers of graphite electrodes used in electric arc furnaces to make steel. GrafTech has so far not lived up to our expectations as the company continues to work through a set of issues from higher channel inventories driving spot electrode prices lower, higher prices for key raw ingredient petroleum needle coke, and general economic worries. GrafTech is better insulated from the increased needle coke costs due to its captive supply covering roughly 2/3 of production, but the lower spot prices for electrodes raises concerns about the stability of GrafTech’s long-term fixed priced sales agreements. Currently, spot prices are above contract prices, but the concerns remain if that relationship inverts. Shares received a boost late in the quarter as it was speculated that GrafTech might be an acquisition target given its cheap valuation (under 5x 2020 P/E and 5x 2020 EV/EBITDA) but instead its controlling shareholder Brookfield announced a secondary offering, further pressuring shares. Partially offsetting this was the company announcing a $250 million stock buyback in conjunction with Brookfield’s secondary. We anticipate additional repurchases by GrafTech given its strong cash flow characteristics and managements stated targets of returning 50% to 60% of free cash flow to shareholders. The concerns surrounding electrode spot prices should subside as the industry works through channel inventories throughout 2020.
From Keeley Asset Management's Keeley Mid Cap Dividend Value Fund fourth-quarter 2019 shareholder letter.
