GrafTech International Stock To Gain 25%

Despite rising more than 15% from its March lows of this year, at the current price of little over $7, we believe GrafTech International stock (NYSE: EAF) is still undervalued. GrafTech International is a leading manufacturer of high quality graphite electrode products essential to the production of electric arc furnace (or EAF) steel and other ferrous and non‑ferrous metals. EAF stock has increased from $6 to $7 off the recent bottom compared to S&P 500 which increased a little less than 50% from its recent lows. The stock has underperformed the broader market as the prices of iron ore have increased at a faster rate than steel, which is expected to eat into the margins of companies operating in the steel space. However, with the gradual lifting of lockdowns, demand from steel players is expected to rise, leading to expectations of an increase in revenue.

With the stock still almost 35% below the levels seen at the end of 2019, we think it has the potential to rise further. Our dashboard What Factors Drove -35% Change In GrafTech International Stock Between 2018 And Now? provides the key numbers behind our thinking.

EAF’s revenues declined 5.5% from $1.9 billion in 2018 to $1.8 billion in 2019. During the same time, margins dropped from 45% to 41.6%. On a per share basis, earnings declined 10% from $2.87 in 2018 to $2.58 in 2019. Despite higher earnings, the stock price remained almost stable during the 2018-2019 period. This was driven by the drop in EPS being offset by a higher P/E multiple. EAF’s P/E multiple saw a modest uptick of 12% from less than 4x to a little over 4x. This was mainly because of more steel players shifting to electric arc furnaces, leading the markets to expect improvement in top and bottom line in the near future. But the P/E multiple dropped in 2020 following the outbreak of the coronavirus pandemic which led to a sharp drop in demand for the company’s products from steel giants. The multiple currently stands at less than 3x. As the steel market restarts operations and recovers, EAF’s P/E multiple is expected to go up, thus driving the stock price higher.

What’s the upside trigger?

The global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. The steel demand from industry players affects the capacity utilization of steel players. This, in turn, impacts demand for EAF’s products which are used by major steel companies. Lower demand from construction and automobile players, has led to a drop in global steel prices in 2020, which had already seen a drop due to the ongoing US-China trade war, thus impacting the steel industry adversely. This was reflected in the recently released Q2 results where EAF’s revenues declined by 42% y-o-y, while earnings nearly halved.

The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. However, with the lifting of lock downs, and as global economies open up, steel demand is expected to rise while easing of supply constraints will provide further fillip to steel players. The US raw steel capacity utilization for the week ending 12th September 2020 was 65.1%, which is significantly lower than 77.4% recorded in the prior year period. However, this is an improvement over the 51% utilization in the beginning of May 2020, which indicates that there are signs of a rebound in activity in the steel space. This is likely to lead to recovery in demand for EAF’s products. Also, with more steel companies turning toward electric arc furnaces instead of the traditional blast furnace, EAF’s sales are expected to go up. The recent surge in Covid positive cases is a concern for the company, as a re-imposition of lock down will delay the recovery process and might even push the stock down. However, another lockdown as was seen in early 2020 looks unlikely as of now. In the absence of a lock down and with investors’ focus already having shifted to 2021 numbers, we believe EAF’s stock could rise to $9. This reflects an upside of about 25% from its current level.

For further insight in the steel sector, see how ArcelorMittal compares with US Steel.

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