Mohnish Pabrai (Trades, Portfolio) made some significant changes to his portfolio at Pabrai Investments during the first quarter of this year, according to the firm's latest 13F filing. Pabrai reduced all of his U.S. stock positions in the first three months of the year.
I say "U.S. stock positions" because these reports only detail the U.S. equity holdings of hedge funds with more than $100 million in assets under management. According to his recent investor letters, Pabrai has been moving his portfolio away from U.S. equity markets into Indian securities over the past few years. He believes there's more value to be found in this market, which is less efficient than its U.S. counterpart.
That being said, his hedge fund does still own some U.S. equity exposure. Heading into 2020, he owned shares of Fiat Chrysler Automobiles (FCAU, Financial), Micron Technology (MU, Financial) and GrafTech (EAF, Financial).
During the first three months of 2020, Pabrai divested 92% of his investment in Fiat according to the 13F. He also sold the entire holding in GrafTech.
GrafTech
Over the past few quarters, I've covered this position several times. GrafTech seemed to be the type of stock Pabrai loved. The market didn't like the company because it had a lot of debt and lots of uncertainty regarding its outlook. However, the company had several take-or-pay agreements with clients which guaranteed a fixed income level for the next few years.
In 2019, these agreements helped the company generate $800 million in cash flow from operating activities. Of this, management returned $360 million to shareholders with dividends and share repurchases and spent another $350 million paying down debt. As I wrote in February of this year:
"$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."
Unfortunately, cracks were already starting to show in the company's business model towards the end of 2019. While GrafTech had around two-thirds of its cumulative capacity signed on take-or-pay contracts, some of these clients had already fallen into financial distress. This left the company with additional capacity it needed to dispose of on the spot market. Prices here were never as attractive or predictable as they were on the agreed multi-year contracts.
Still, heading into 2020, management was confident that it would be able to shift the extra capacity into the market considering the relatively attractive outlook for the global economy. The Covid-19 crisis has completely thrown this projection off course. Not only is GrafTech going to struggle to find buyers for this capacity in the current economic environment, but it may also lose more customers on the take-or-pay agreements. Companies tied into these onerous contracts tend to struggle during economic downturns.
Negative outlook
All of the above is bad news for GrafTech. The company needs cash to reduce its debt. The economy may pick up towards the second half of the year, but we don't know that yet. In the meantime, the company has to meet its obligations to lenders.
Earlier this year, in his first-quarter letter to investors, Pabrai declared that he decided to sell his Fiat holding because the company's outlook has become too difficult to predict. I think he likely did the same with GrafTech. We don't know whether the company will be able to recover in the second half of the year, and its massive debt pile is a severe concern in the meantime.
At the end of 2019, GrafTech was a low-risk investment because it had guaranteed cash flows, which suggested the company could maintain its debt repayments. With these cash flows likely to be disrupted over the next 12 months as clients go bankrupt, the company now seems to have become a high-risk investment.
Disclosure: The author owns no share mentioned.
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