Graftech Manages the Heat of Competition

by Debra Fiakas CFA

Products like Graftech’s ultra-thin heat spreader help customers manage the heat. Investors think restructuring will help Graftech do the same.

Feeling the heat of competition, graphite materials supplier Graftech International Ltd. (GTI:  Nasdaq) has initiated a restructuring of sorts.  The company’s two highest cost graphite electrode plants will be closed.  Those are located in Brazil and South Africa.  A machine shop in Russia will also be shuttered.  Locks will go on the doors in these locations by the end of June 2014.

Downsizing capacity is expected to yield substantial savings.  Total production capacity will be reduced to about 60,000 metric tons, which eliminates fixed plant costs.  More importantly the closures are expected reduce inventory requirements.  The company has stated that working capital improvements should reach $100 million over the next year and a half.

What is more, about 600 employees or about 20% of the company’s workforce will be getting pink slips.  The company estimates annual savings of $35 million.  That represents about 3.6% of annual direct costs, which should drop right to the gross profit margin.

The savings will come in handy as the company turns from older, declining markets to new, more lucrative sources of demand.  Graftech staged a major media event in August this year to publicize the opening of a new manufacturing facility in Ohio.  That new plant, which was purchased last year for $3.0 million, is dedicated to the production of a thermal management product intended for smartphones and tablets.

Of course, the restructuring effort comes with its own price tag.  Graftech management says they need to use about $30 million in cash over the next three quarters.  There is another $75 million in non-cash expenses related to the write-down of certain assets.  Shareholders have already seen about $18 million of these write-off expenses pass through Graftech’s income statement in the third quarter.  The rest will follow in the next two quarters.

So far investors have reacted with great enthusiasm to Graftech’s strategy.  The stock climbed 29.5% in the first week following the restructuring announcement.  No one would blame shareholders from taking some profits at the current price level near $11.36.  Price oscillators such as the Residual Strength Index suggest the stock has for the time being entered over bought territory.  Just the same we do not believe the last chapter has been written in the Graftech story.  If the stock retraces to the pre-announcement level, investors would have compelling chance to build positions in what is arguably a stronger, more competitive operation.
 
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.