Hedge Funds Buying GrafTech International Ltd (GTI)

Several hedge fund managers newly purchased shares of GrafTech International Ltd (NYSE:GTI), including Peter Schliemann of Rutabaga Capital Management, Peter Muller of PDT Partners and Israel Englander of Millennium Management. Among other shareholders are Chuck Royce’s Royce & Associates (the third largest shareholder, owning 11.9 million shares or a 9% stake), Mario Gabelli’s GAMCO Investors and John Overdeck and David Siegel’s Two Sigma Advisors.

MILLENNIUM MANAGEMENT

GrafTech International is a $1.4 billion market cap company that manufactures a broad range of graphite electrodes, which are products essential to the production of Electric Arc Furnace (EAF) steel and various other ferrous and nonferrous metals. It also produces needle coke products, which are the primary raw material needed in the manufacture of graphite electrodes. As the only major producer of graphite electrodes that is vertically integrated, GrafTech International Ltd (NYSE:GTI) can provide high quality products at a low cost and leverage its research and development into developing engineered solutions for its higher growth end markets, which include electronics, chemicals, aerospace and transportation.

The stock rallied sharply in late October 2013 after the company reported better-than-expected third quarter earnings and announced a rationalization plan that would shut down two of its highest cost graphite electrode plants by the end of the second quarter of 2014, and reduce its global workforce by 600 people (or 20%). Financially the plan aims to achieve $75 million of annual cost savings ($50 million of which will be completed in 2014) and improve cash flow by $150 million ($75 million in each of 2014 and 2015). For 2014, management expects EBITDA of $150-180 million (versus $144 million in 2013) but sees its peak potential at $500-600 million as industrial materials rebound, engineered solutions grow and cash flows improve. Operating cash flow for this year is projected to be $130-160 million (versus $117 million in 2013), a portion of which will be used for share buybacks (there are 10 million shares remaining on its current repurchase authorization, or 7% of its common shares outstanding) while the balance will be reinvested in the business as well as used to fund acquisitions.

In late January 2014, an investor group led by Nathan Milikowsky, a former director of GrafTech International Ltd (NYSE:GTI) who was ousted, disclosed a 5% stake in the company and nominated five members (including himself) to the board. Given the plan management has already put forth to improve its profitability and cash flow, it is not clear how much more can be accomplished by Milikowsky, whose personal history with the company can be both a positive (in terms of his familiarity with its inner workings) and a negative (as his agenda can be construed by some to be not totally aligned with shareholders).

Reflecting its improving prospects, GrafTech International Ltd (NYSE:GTI) trades at a forward EV/EBITDA multiple of 12.4X, a modest premium to the peer group median of 11.2X. Given the approximate 300 basis point negative difference between the EBITDA margins of GrafTech’s and its peers, any narrowing of this gap would provide a boost to the stock’s valuation. Furthermore, if the company demonstrates progress towards its peak EBITDA, which is three to four times current levels, both estimates and the multiple applied to them would increase meaningfully.

Disclosure: none

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