One Free Puff?
Ben Graham often talked about "Cigar-Butt" style of investment. A company that you could purchase at a discount to its tangible assets with the aim of enjoying the possibility of a one time, substantial gain with minimal downside risk. Typically these businesses were obscure, unpopular or had encountered a significant amount of difficulty due to a myriad of reasons that, for one reason or another, the market had overlooked.
One company that I believe could represent such a value opportunity is GrafTech International (GTI). GrafTech is a producer of Carbon and Graphite for use in both steel production and the burgeoning industry of engineerd carbon.
Though GrafTech is engaged in the production of cutting edge technology, the company has a venerable history - dating back well over a century. Though the mere fact that a company has been around for a long time does not indicate much about its current state of affairs - it does indicate the potential for the presence of a healthy corporate culture and an ethic of stewardship - which is somewhat reflected in the insider ownership of the company - currently at 12%. Though Graftech conducts its business on a global scale it is dependent upon the performance of other industries, as the majority of its business is related to steel production, to drive profits.
One Might Have Reason to Think It's Really Cheap...
Using quantitative metrics, there are several reasons GrafTech might be undervalued. The company is currently priced at $6.84 against a book value of $10.05 and cash per share of $0.13. The stock has declined in price by a significant amount, over 45%, in a one year period. It also has a price to sales ratio under 1, meaning that investors are purchasing the sales of the company at a discount on a dollar for dollar basis.
Despite the considerable decline in earnings - possibly a byproduct of the numerous recent acquisitions by the company or the sluggishness of the worldwide steel industry (a large portion of GrafTech's business is dependent upon carbon-related steel production), the company has been able to earn .81 cents per share of net income. Per the CEO's conference call, the company has sought to freeze capital expenditures and reduce employees as well as the pay of some individuals until the company is able to return to higher levels of profitability.
In the most recent conference call, the CEO also mentioned the growth of the Engineered Solutions segment of GrafTech's business by 18%, a segment that has the potential to be a significant driver of growth in the future as nanotechnology increases in visibility and viability on the world stage. Carbon is a critical element of future nanotechnology, with two materials created from the element (nanotubes and graphene) being utilized in a staggering variety of applications.
Is It Really Cheap?
Despite the considerable opportunities in pursuing the "cigar-butt" style of investing, there are also definite risks. GrafTech currently has a negative levered free cash flow and a minor cash position on its balance sheet in addition to carrying a large amount of debt ($571 million). The company also closed financing of $300 million of unsecured notes in November - with the intention of using the proceeds generated to pay down debt from its revolving credit facility.
Though there are numerous valid reasons for companies to take a large debt position, including expansion and financing acquisitions, it is important to remain skeptical when there is a large portion of debt relative to the company's current cash position. Despite the fact that the management of GrafTech might be attempting to implement a multi-stage, long term business plan of consolidation of present business and expansion into the Engineered Carbon arena - the possibility of economic headwinds upsetting a carefully crafted business plan are considerable.
For a company with a diversified global position in multiple sectors in conjunction with expanding growth in an emerging area of technology, I believe that it is not unlikely that a large company seeking exposure to carbon related nanotechnology would view GrafTech as a potential acquisition in light of the currently depressed price of the shares relative to assets.
I believe that if GrafTech's price declines further, there will be considerably less risk to investors. From an examination of the historical pricing of the security, as the company approaches its 2008 crisis low of approximately $4.46 per share, I believe that it will become even more attractive as an investment - in particular because of the recent string of acquisitions made by the company in the past several years as it attempts to expand into the burgeoning field of engineered carbon. Despite the fact that acquisitions do not always add value, I believe that if GrafTech diversifies successfully into the engineered carbon product market there is significant potential for future growth as nanotechnology develops.
I would caution investors to do more research about this company before attempting to take a puff from the cigar-butt, even though it could be a rewarding one. Caveat Emptor.