EAF - GrafTech

[peterHK]

His comparison to IPSCO really feels like a stretch. There you were buying a no-debt company for 2x earnings and 2 years of contract. Okay, so you get a free company operating in the spot market two years from now--seems like a straightforward thesis that doesn't require strong convictions about the steel industry.

 

Here, you have $2B of debt and a bit more than that in net income coming from the LTAs. So we're mostly transforming the capital structure, not working our basis in the company anywhere near $0. It's still a company you're paying ~$3B for, in a market where there's a lot of weird stuff going on and a graveyard full of corpses. 1/3 of a portfolio in EAF sounds insane to me; I'm not sure I understand where he is coming from at all.

 

His risk management ability is basically 0. The guy buys cheap, but often really really terrible and cyclical businesses, and then takes them in huge size. Some years he does great, others he has like 60% or 70% drawdowns.

[elliott]

His risk management ability is basically 0. The guy buys cheap, but often really really terrible and cyclical businesses, and then takes them in huge size. Some years he does great, others he has like 60% or 70% drawdowns.

 

Do you know his performance? I thought his letters were not widely available, so if they are instead being published, would you mind sharing the source? Thank you :-)

(13Fs/Tiprank/etc are no good. As far as I know Pabrai has been investing globally for quite some time now)

[RadMan24]

His comparison to IPSCO really feels like a stretch. There you were buying a no-debt company for 2x earnings and 2 years of contract. Okay, so you get a free company operating in the spot market two years from now--seems like a straightforward thesis that doesn't require strong convictions about the steel industry.

 

Here, you have $2B of debt and a bit more than that in net income coming from the LTAs. So we're mostly transforming the capital structure, not working our basis in the company anywhere near $0. It's still a company you're paying ~$3B for, in a market where there's a lot of weird stuff going on and a graveyard full of corpses. 1/3 of a portfolio in EAF sounds insane to me; I'm not sure I understand where he is coming from at all.

 

His risk management ability is basically 0. The guy buys cheap, but often really really terrible and cyclical businesses, and then takes them in huge size. Some years he does great, others he has like 60% or 70% drawdowns.

 

Why are you all hating?

 

1.) Are you investors in his funds? If so, his returns have been pretty good lately.

 

2.) He doesn't tell you to buy his ideas, he just shares them and his strategy.

 

3.) A lot of folks on this thread are over analyzing this idea. It's not that complicated.

[Guest roark33]

His letters are pretty accessible if you look around on twitter, etc.  Basically, if you exclude his few 2-3 years, he has trailed the S&P since then...

[elliott]

His letters are pretty accessible if you look around on twitter, etc.  Basically, if you exclude his few 2-3 years, he has trailed the S&P since then...

 

Havent found them in Twitter, neither in Reddit (and there are some good compilations there). Would you mind sharing someone to follow in twitter?

[elliott]

I have not gone through the financial statements of the Q3 yet, but attended the call today.

• Customers still have excess inventory. Management believes the excess will not be consumed until H2 of 2020.
  
• Even though the company does not comment on Graphite electrode prices, it is understood that they are low/lower.
  
• A couple of customers have gone bankrupt, and management has reduced the volume of contracted sales accordingly.
  
• Management would be willing to renegotiate a contract, provided there is a good reason for it and that the "value" for the company is preserved.
  
• Needle coke prices have also decreased.
  

 

Shares are down 7%.

[johnny]

Gonna have to listen to the call, I'm blown away that they actually said in public that they are flexible on the LTAs. I can't believe they answered a question like that. The shares deserve to be down 7% on the basis of that statement alone.

[Fitz]

David Francis Gagliano -- BMO Capital Markets -- Analyst

 

No. I was actually more asking about the other topic that comes up quite a bit in terms of I guess more directly are you having customers approach you to renegotiate those existing contracts that are in place?

 

David J. Rintoul -- President and Chief Executive Officer

 

So our approach to customers that inquire we're flexible in our approach to that as long as the outcome of their needs are such that GrafTech and our shareholders are a whole at the end of the day with the way the initial contract stood. So there haven't been any significant changes heretofore to speak to but I would be -- we would be remiss if we were not as good business people partnering with our customers to be open to things that might be of value to them that still allow us to be in a situation where the value of the LTA is in fact kept intact. So that's our position on that subject.

 

David Francis Gagliano -- BMO Capital Markets -- Analyst

 

Okay, thanks very much.

 

Operator

 

Your next question comes from the line of Alex Hacking with Citi. Your line is open.

 

Alexander Nicholas Hacking -- Citigroup Inc Research Division -- Analyst

 

So just a follow-up on those last comments. I would -- am I correct in assuming that what you're saying there is that you are willing to potentially cut prices on existing LTAs as long as customers are willing to extend those out? So in that sense the customer is getting potentially a lower near-term price but you guys are locking in more volume into the future is -- would that be an example of the kind of flexibility that you were talking about?

 

David J. Rintoul -- President and Chief Executive Officer

 

Alex not quite. I was very deliberate in saying that the outcome of those discussions would have to be that the value of the existing LTA is kept intact. So that would mean if you look at the net present value or the value of the LTA at this point in time whatever changes we want to make would have to preserve obviously for the -- in the interest of our shareholders that NPV. So it's not quite as simple as your example might suggest.

 

Alexander Nicholas Hacking -- Citigroup Inc Research Division -- Analyst

 

Okay. Could you give an example of what you're talking about be more specific I guess? Or you don't want to do it?

 

David J. Rintoul -- President and Chief Executive Officer

 

I don't think on this call that I want to put out into those and the marketplace suggestions on such modification because I think it's an individual one-on-one. We've had discussions with certain customers. And at the end of the day some have decided to think through and others have said no we'll just leave the LTA in place. There are a number of combinations and permutations that can allow us to assist the customer in a near-term request to preserve the net present value of the LTA. So I don't think it's inducive or good business for us to try and align on this call the combinations and permutations that could exist in that. It's really a customer-by-customer preference and personal. What matters to one customer might not matter to another in terms of how they might view that. So I don't expect that there'll be a great number of those things transpire. But as good business people we are always willing to work with our customers to find an optimal solution that works for both parties.

 

 

 

------

 

Looks like they did a decent job of half answering the questions; with "We've had discussions with certain customers. And at the end of the day some have decided to think through and others have said no we'll just leave the LTA in place. There are a number of combinations and permutations that can allow us to assist the customer in a near-term request to preserve the net present value of the LTA. "

 

 

Looks like Bayou Steel and Hamilton Specialty are two smaller EAF producers that have gone bankrupt recently. Bayou purchased a majority of their steel from Chinese scrap and were heavily affected by Tariffs.

 

---

 

I think this answers one important question, what happens with the LTA's during a bankruptcy and we can safely say there value goes to zero...

[peterHK]

The LTA stuff was basically the entire thesis.

 

I gotta say this mgmt is one of the worst at communications I've seen. The flip flopping on capital allocation, cageyness on pricing and now this sort of is amazing.

[racemize]

His letters are pretty accessible if you look around on twitter, etc.  Basically, if you exclude his few 2-3 years, he has trailed the S&P since then...

 

He has outperformed the index (for PIF2) `80% of rolling 5 year periods:

https://drive.google.com/file/d/0BxTPR9eP5nWebFdOTnZSR3l1eVk/view

 

See page 19.

[Guest roark33]

This performance record created doesn't account for what I am trying to point out, that if you exclude the first two years, he has significantly underperformed. Same thing with Guy Spier. 

[RadMan24]

This performance record created doesn't account for what I am trying to point out, that if you exclude the first two years, he has significantly underperformed. Same thing with Guy Spier.

 

Rubbish. His performance has cycles, would you rather have consistent returns that ultimately give you 12% or volatile returns that give you 15%?

 

All this talk on this board is like people expected EAF to do better than steel market which is in the duldrums. Demand will come back. EAF had ttm fcf of what $770m? And have another $200-300million left to ear mark debt and capital returns?

 

Again, focus on the minor minute possibilities if you like but it really misses the broader picture.

 

 

[peterHK]

This performance record created doesn't account for what I am trying to point out, that if you exclude the first two years, he has significantly underperformed. Same thing with Guy Spier.

 

Rubbish. His performance has cycles, would you rather have consistent returns that ultimately give you 12% or volatile returns that give you 15%?

 

All this talk on this board is like people expected EAF to do better than steel market which is in the duldrums. Demand will come back. EAF had ttm fcf of what $770m? And have another $200-300million left to ear mark debt and capital returns?

 

Again, focus on the minor minute possibilities if you like but it really misses the broader picture.

 

Here's the thing. Most clients don't want volatile 15% returns. Many clients withdraw funds periodically, so the volatile return structure increases the risk of a bad result for the client. If you're in wealth building mode and never have to withdraw then yes, you don't care, but the fact is that is not most people so to say that one would prefer a higher number IMO misses this nuance.

[ValuePadawan]

I emailed GrafTech to see if they could help clarify what they meant in regards to the LTAs I got fairly boilerplate answers but perhaps you'll find them useful.

 

Q: Does GrafTech require a small, medium or large percentage of their customers with LTAs to have parent guarantees or collateral arrangements?

 

A: The majority of the customers have strong balance sheets with a weighted average cost of debt of ~4.2% as of our IPO.

 

Q: Does GrafTech track the counter-party risk of its customers after they have signed the LTA?

 

A: yes

 

Q: What can GrafTech do to mitigate that risk if a customer is becoming insolvent and their LTA does not include a parent guarantee or collateral arrangement?

 

A: This is relatively rare – i.e. most customers who are financially weak have credit protections and vice versa.

 

Q: It was stated in yesterday’s call that these contracts are flexible as long as the overall value is maintained for shareholders, as a shareholder I’m curious what that means as it is kind of ambiguous.

 

A: We are willing to work with customers if possible, but the contracts are fair, well-worded, enforceable contracts.  We would need to be made whole for any changes we agreed to.

 

Q: If a contract is cancelled due to a bankruptcy can that contract be replaced to another customer quickly (matter of months) to keep visibility or does it take a while (matter of years) to repurpose that capacity which was lost in a new LTA?

 

A: A contract in bankruptcy is not cancelled.  It falls below the threshold for collectability and therefore is excluded from our accounting and IR disclosures; however, we could and would continue to pursue collection.  It could be some time for that to resolve.  In the meantime, we could sell the electrodes elsewhere.

[elliott]

Thanks for sharing EAFs reply.

 

As you say, management was a little bit ambigous about contract modifications.

 

 

[Steven B]

I have respect for Mohnish and  but the fact is that if you take out the first 3 years he has under performed. Fact. No bashing involved.

 

 

 

 

This performance record created doesn't account for what I am trying to point out, that if you exclude the first two years, he has significantly underperformed. Same thing with Guy Spier.

 

Rubbish. His performance has cycles, would you rather have consistent returns that ultimately give you 12% or volatile returns that give you 15%?

 

All this talk on this board is like people expected EAF to do better than steel market which is in the duldrums. Demand will come back. EAF had ttm fcf of what $770m? And have another $200-300million left to ear mark debt and capital returns?

 

Again, focus on the minor minute possibilities if you like but it really misses the broader picture.

[Lakesider]

Doesnt he own a crap load of moutai shares? surly the past few years haven't been so bad for him.

[valueinvestor]

He sold out of Moutai last year — but did catch a 4-5 bagger along the way.

 

I do believe Pabrai has significantly outperformed over time, with his significant outperformance coming in the early years and likely the last few years. Certainly a rough patch around the crisis.

 

I also agree with some of the other folks on this thread. I think people are significantly overthinking this investment (forest vs trees). The facts are:

-NC Supply is constrained

-Contracts are guaranteed

-They’re vertically integrated, leaving room for contract renegotiation

-Debt isn’t overbearing

-And yet, if you view valuation as a probabilistic range, they’re trading far closer to their floor than they are their ceiling. (And at a price of 10-11 where a lot of us bought it, it was below the rational floor). So now we sit and wait.

 

Happy Thanksgiving all

 

Unless it goes lower, and as value investors we bought more because it is cheap but only to be "brookfield" when they buy us out at $10-11. (Yes an oversimplification, but certainly emphasizes the point I am trying to make).

[skanjete]

Basically, this is a commodity business.

 

My experience is that the best time to buy commodity businesses is when commodity prices are depressed, not when they are at sky high prices.

 

The forward contracts don't change this fact. They only postpone the effect of lower commodity prices in the future.

 

The forward contracts reflect somewhat his investment in ipsco, but that was an environment with rising commodity prices from a very low base. This imo is a fundamental difference.

[Guest roark33]

"Contracts are guaranteed."

 

If your counterparty is hurting, you are hurting, no matter what you say in your conference call about "guaranteed contracts".  It happens so often, most recently in oil field services companies. They all had guaranteed contracts, but even without bankruptcy of their customers, those customers come back and asked to have the agreements re-cut. 

 

You just have to think harder about the idea that the revenues are not guaranteed. 

[RadMan24]

He sold out of Moutai last year — but did catch a 4-5 bagger along the way.

 

I do believe Pabrai has significantly outperformed over time, with his significant outperformance coming in the early years and likely the last few years. Certainly a rough patch around the crisis.

 

I also agree with some of the other folks on this thread. I think people are significantly overthinking this investment (forest vs trees). The facts are:

-NC Supply is constrained

-Contracts are guaranteed

-They’re vertically integrated, leaving room for contract renegotiation

-Debt isn’t overbearing

-And yet, if you view valuation as a probabilistic range, they’re trading far closer to their floor than they are their ceiling. (And at a price of 10-11 where a lot of us bought it, it was below the rational floor). So now we sit and wait.

 

Happy Thanksgiving all

 

I concur and welcome!

[khturbo]

I can't find the letter anywhere but I'm pretty sure Pabrai was down ~50% in 2018.

[ValuePadawan]

I can't find the letter anywhere but I'm pretty sure Pabrai was down ~50% in 2018.

His largest holdings were Fiat and Rain and in 2018 Fiat went from 24 to 14. Rain went from 400 to 120 so its very possible.

 

That being said he bought rain for 40 and Fiat for 5.

[RadMan24]

Aren't EAF shares up like 30-40% since this whole Pabrai returns thing went off on this thread?

[brose514]

Interesting price movement on block trade + buyback. Wonder if timing coincides with potential Dec.15th tariffs. Seems like Brookfield wants to unload quickly and there may be overhang on stock until that's completed.

 

On another note, was wondering why CEO has no skin in the game?