Skilled value investor Mohnish Pabrai (Trades, Portfolio) has been avoiding U.S. stocks for the past few years because he's been unable to find any attractive value opportunities. Instead, he's been investing his clients' money in international stocks, such as India's Rain Industries.
With this being the case, investors noticed when Micron Technology (MU, Financial) appeared in the Pabrai Investments portfolio at the end of 2018. And since then, Pabrai has also added another U.S. stock to his portfolio.
According to Pabrai's 13-F filing for the second quarter of 2019, Pabrai Investments initiated a new position in U.S.-based GrafTech International Ltd. (EAF, Financial) during the second quarter of 2019. According to the filing, the position is worth around $47 million, making it a 16% portfolio weight. However, 13-F reports don't include international holdings. Pabrai Investments manages around $600 million in total, which indicates that the value investor has devoted around 7.8% of his overall portfolio to the company.
So, what's so special about GrafTech? At first glance, it appears as if this is one of Pabrai's traditional "P/E of 1 stocks." After a busted initial public offering last year, the stock is currently trading at a deeply discounted forward price-earnings ratio of just 4.3, and it has a dividend yield of 2.9%.
Market leader
GrafTech's valuation looks cheap, but what does the company do? The business manufactures products that are integral in the manufacture of steel -- specifically, graphite electrodes, which, according to the company, are "the only product that can conduct the power and withstand the heat necessary to make steel." A key component of electrode production is petroleum needle coke.
GrafTech owns and operates Seadrift Coke L.P. This is one of the world's only standalone petroleum needle coke plants so it can count on continual supply for electrode production. According to management, this gives the business an edge over the rest of the market. Other companies are dependant on third party suppliers to meet their requirements for needle coke. The vertical integration with Seadrift gives GrafTech an edge.
Private equity owner
GrafTech was bought to the market by Brookfield, its previous private equity owner. Brookfield acquired the business in 2015 when GrafTech was struggling. According to a case study from the private equity business on the company, when the company was acquired, "the company was generating roughly $45 million of Ebitda and revenue of around $530 million."
However, after three years of private equity ownership, $100 million of annualized cost savings and a recovery in the steel market, the firm produced $1.2 billion of Ebitda for 2018.
Today, Brookfield still owns a significant stake in the business, and the firm's partners hold several positions on the board.
Cash cow
Like all private equity floats, GrafTech hit the market with a lot of debt. As of June 30, 2019, GrafTech had cash and equivalents of $205 million and total debt of $2 billion. The good news is that the business is highly cash generative.
Cash flow from operating activities was $202 million in the second quarter of 2019. Debt is coming down. At the end of September 2018, the company had cash equivalents of $103 million and total debt of $2.2 billion.
At the same time, the company is also paying out a dividend and returning cash to investors with share repurchases. For example, alongside second quarter 2019 results, management announced a $100 million share repurchase authorization. And on August 13, 2018, the company repurchased 11.7 million shares directly from Brookfield at $19.25 per share for a total of $225 million. Total cash generated from operations in the whole of 2018 was $837 million, after excluding capital spending.
So overall, it looks as if this is a dirt-cheap industrial business that is throwing off cash after a multi-year turnaround instigated by is private equity owner. From a financial standpoint at least, there is plenty to like about GrafTech, although as it operates in a cyclical industry, the company's outlook is fairly difficult to determine.
Disclosure: The author owns shares in GrafTech.
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