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Rupert Hargreaves
Rupert Hargreaves
Articles (1078)  | Author's Website |

Pabrai's GrafTech: What's New?

A look at one of Pabrai's largest holdings

February 07, 2020 | About:

Shares in one of Mohnish Pabrai (Trades, Portfolio)'s favorite U.S. equity investments, GrafTech International (NYSE:EAF), plunged by around 10% yesterday after the company reported its fourth-quarter and full-year 2019 results.

Pabrai holdings

According to Pabrai's latest 13F filings, the value investor owned 5.5 million shares in this industrial business at the end of September 2019. This position was worth a total of $71 million, which I estimate makes it about 10% of Pabrai Investments' overall equity portfolio.

Based on Pabrai's past history and comments, it seems that this is one of his is high uncertainty low-risk investments.

GrafTech is dealing at a low single-digit price-earnings multiple, but has around two-thirds of its earnings guaranteed through 2022 on take-or-pay contracts, which guarantee a set level of income for the producer of graphite materials.

These contracts helped the company achieve relatively impressive results in 2019. GrafTech reported fourth-quarter earnings of $0.61 per share on revenue of $414.61 million, beating expectations for $0.55 per share in earnings on revenue of $402 million.

On top of this, GrafTech said it generated more than $800 million in cash flow from operating activities, returning $360 million to shareholders via dividends and share repurchases and also paying down $350 million worth of debt.

So far, so good. $800 million of cash flow on a $3.1 billion market capitalization looks extremely attractive. The existence of the take or pay contracts should guarantee that this profitability lasts, or that is the theory anyway.

Bankruptcy problems

Unfortunately, it looks as if the company is running into some problems with these contracts.

Take-or-pay contracts are always contentious because they force customers to commit to a set purchase level. This can cause financial instability and even bankruptcy for customers because they have to keep buying the product even if they do not need it.

This is good news for GrafTech but bad news for its customers, and as economic uncertainty bites, customers are collapsing. This could mean lower revenues for GrafTech.

As management explained on the company's 2019 earnings conference call:

"GrafTech has sold about two-thirds of our cumulative capacity via long-term take-or-pay contracts. These contracts provide profitability and visibility of earnings. As you know, certain of our customers have filed for bankruptcies and other customers are experiencing some financial difficulties. With both developments, we expect to impact contracted sales volumes to a degree moving forward. In response to this, along with some variability permitted within certain LTA provisions, we have adjusted our 2020 estimate shipments of volumes."

GrafTech says that it stands ready to help customers that fall into financial difficulty. Management's comments on the calls suggest that the company is happy to renegotiate take-or-pay agreements if customers suffer financial distress.

Difficult to tell

The problem for shareholders is that it is difficult to tell how much of an impact this will have on the bottom line.

Possible customer bankruptcies have always been a risk for the company, and it is something management warned of last quarter as well, so this is nothing new.

Nevertheless, it'll be interesting to see how the situation develops over the next 12 months and what sort of impact bankruptcies will have on revenue and income.

Having said that, right now shares in this electrode producer are dealing at such a low valuation, the risk-reward ratio will continue to look attractive even if earnings fall by 50% or more.

Management is planning to continue returning cash to shareholders in 2020 and reducing debt at the same time. This appears to be a very positive capital allocation strategy and only improves the investment case.

Overall, while the market seems to think the risk of investing in GrafTech has increased over the past 24 hours, the risk of customer bankruptcies is something that business has always had to deal with. Its low valuation reflects that. Further cash returns and debt reduction over the next 12 months should improve sentiment and could drive a re-rating of the stock.

Disclosure: The author owns shares in GrafTech.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


Rating: 4.8/5 (5 votes)

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Comments

Nicola Guida
Nicola Guida - 1 week ago    Report SPAM

Hi Rupert,

thank you for your article.

According to the latest 13F, Graftech accounts for 27% of the total Dalal Street (Pabrai's investment vehicle) Portfolio. You can find the document here.

In a few days we should learn if anything has changed during Q4.

Best Regards,

Nicola

urrangen
Urrangen premium member - 6 days ago

Hi Nicola. The 13F only shows investments in the US. Dalal Street has also invested in Turkey and India. The author is right that Pabrai has invested about 10% of the total portifolio in Graftech.

Nicola Guida
Nicola Guida - 6 days ago    Report SPAM

Hi Urrangen, I missed the "overall". Thanks for pointing it out.

@Rupert: any hint on where to find Pabrai's overseas investments?

Best, Nicola

Rupert Hargreaves
Rupert Hargreaves - 6 days ago    Report SPAM

Hi Nicola,

Sorry I missed your earlier comments. Pabrai's investments are a little difficult to break apart. He manages three funds under the Pabrai Investment Funds vehicle. These are PIF2, PIF3 and PIF4. They all have different exposures and weightings. From what I remember, 3/4 have the most exposure to Turkey/India and 2 the least. In total AUM is around $600m/$700m so that makes EAF 10% roughly.

Most sources report the total value of investments as a % of the whole AUM. We don't know what Pabrai owns exactly in India/Turkey because there's no obligation to report international holdings. That said, I've written about one holding before https://www.gurufocus.com/news/732723/why-mohnish-pabrai-likes-indias-sunteck

I hope that helps!

Nicola Guida
Nicola Guida - 5 days ago    Report SPAM

Hi Rupert,

yest it helps! Thank you for the additional info. :)

Best, Nicola

sergioapaiz
Sergioapaiz premium member - 4 days ago

Hi Rupert,

Thanks for the article.

Looking at GrafTech financials in Gurufocus, they have negative Total Equity. Could you give your take on this and how this would impact valuation and risk?

Thanks,

JOSEEE2
JOSEEE2 - 3 days ago    Report SPAM

The demand for Electric Arc Furnace is growing, my question is why are some costumers having issues? Bankruptcy???

Needle coke prices spiked increasing prices to costumers, is that why? My thought is in 2018 companies bought extra inventories to be ahead of the China tariff situation which caused a spike in needle coke prices. I think likely in 2020 we will work off inventory. I am buying EAF because I believe demand will kick in at some point. Right now the China corona problem is not helping or can it cause customers to buy from EAF that haven't before??? I just worry why is Brookfield selling, my thought is they saw the situation and taking profits..... when it drops buy it back at lower levels. what do you all think?

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