A Closer Look At Graphite As Market Stabilizes And Outlook Improves

by: Josh Hutheson

Graphite stocks have flown under the radar over the past six months, as the price for the mineral has been sluggish. However, with the price beginning to stabilize and the near-term outlook improving for graphite, now may be as good a time as ever to take a closer look into the graphite market.

Graphite demand and prices have increased substantially over the past few years due to the ongoing modernization of China and other emerging economies, which has resulted in strong demand from traditional steel and automotive markets. In addition, Li ion batteries and other new applications such as vanadium redox batteries, fuel cells and nuclear power have the potential to create significant incremental demand growth.

China currently produces over 70% of the world's graphite, and an export tax and a licensing system have been instituted to restrict exports and encourage value added processing in China. Recently, the Chinese government proposed a new set of rules and standards for graphite mines, which will make them much more difficult to operate and build. These proposals follow calls for REE-type protection and quotas from Chinese producers, and the formation of a state-owned amorphous graphite monopoly that has acquired and is consolidating 210 amorphous graphite mines down to 20 and reducing production capacity from 600,000 to 510,000 tons per year. No new graphite mines were built during the recent economic cycle, and the supply situation will become more acute as Chinese restrictions increase and economies recover. Both the European Union and the United States have declared graphite a supply critical mineral.

In May, graphene, the material found in graphite, was profiled in the Economist. The magazine said that graphene has gained a reputation as a wonder material. It is the best conductor of heat at room temperature yet discovered, and is 40 times stronger than steel. It is also a semiconductor whose electrical conductivity is 1,000 times better than silicon's. This means it could be used to make devices far more sensitive than is possible now, leading some to predict that it will one day become the material of choice for computer chips.

Recent news on price trends for graphite has been positive. Market observers said that prices continued to stabilize. Looking forward, the outlook seems brighter. Although prices are expected to remain stable until the end of 2012, they may start rising in January or February of next year when graphite customers start buying again after the winter shut-down of mines in China.

A recent analyst report from Mackie Research Capital offered optimism as well. The analyst noted that the steel and refractory markets consume 40% of graphite produced, and China produces over 50% of the steel supplied each year. The current trends are showing that both production and consumption of steel continue on an upward trend, suggesting that graphite is experiencing a boost in demand. Also, the analyst noted that graphite prices are poised to inflect to the upside, considering the fact that prices for steel and iron ore have bottomed.

Last week, there was M&A news in the graphite space, suggesting that investors still look favorably upon graphite. Zenyatta Ventures (OTCPK:ZENYF) and Cliffs Natural Resources (NYSE:CLF) announced that Zenyatta has agreed to acquire 100% ownership of the Albany graphite deposit. The property is the only and largest ''vein type'' graphite deposit under development in the world. Recently, a first pass beneficiation test at SGS Canada demonstrated a simple concentration and leaching process capable of producing a 97.2% C (total) graphite product from a rough concentrate. Mineralogical work shows the graphite material to be very simple, and that it contains insignificant amounts of undesirable material. Work is ongoing to target ultra-high purity levels of >99.0% C with results from a second series of tests expected soon.

Some of the world's largest companies are researching graphene. BASF and the Max Planck Institute for Polymer Research just opened a joint research laboratory for graphene. Last year, IBM's (NYSE:IBM) researchers created the first graphene based integrated circuit. Other notable companies involved in graphene research include Intel (NASDAQ:INTC) and Dow Chemical (DOW).

Below are three graphite stocks that I see as compelling opportunities:

Graftech International (GTI) offers graphite material solutions in a wide range of industries and end markets, including steel manufacturing, advanced energy and latest generation electronics. Graftech operates 19 principal manufacturing facilities on four continents and sells products in over 70 countries. Analysts are bullish on the stock, as the mean price target on GTI is just over $15 a share, suggesting upside of nearly 60% from the last available price ($9.52 as of the November 27, 2012 close).

Graftech's Q3 results were very strong as well. On October 25, 2012, the company reported EPS of 22 cents a share versus a consensus estimate of 18 cents a share. Investors rewarded the company for its great quarter and sent the shares up 15% on the day. Third quarter results came in ahead of expectations due to good cost control and overhead management, along with solid performance from the company's Engineered Solutions business.

USA Graphite (OTC:USGT) is a US exploration company focused on the acquisition, exploration and development of world-class graphite properties in North America. The company owns a 100% stake in the Blue Wing Mountain Graphite property, a strategic project located in Pershing County, Nevada. The property consists of 96 lode claims covering an area of approximately 1,985 acres. Road access to the project is excellent, as it is situated directly between I-80 East and US-395 North. Keep in mind, Pershing County is well known for its mineralogical potential, with mines such as the Florida Canyon Mine, Colado Mine and Empire mine all located within the region.

Initial prospecting and geological analysis on the claims confirmed the presence of flake graphite at surface. The dominant rock type on the property is hornfels, which are dark grey to black in color with pockets of flaked graphite throughout the known outcrops. Extensive sections of the Blue Wing Mountains Graphite Project contain abundant chiastolite (andalusite) crystals in a matrix of graphite-rich, pelitic pyroxene-hornfels. The size of the property and the quality of graphite located there lead the company to believe that the Blue Wing Graphite property could host a multi-million ton graphite mine, according to CEO Wayne Y. Yamamoto.

Northern Graphite (OTCQX:NGPHF) is a Canadian company that has a 100% interest in the Bissett Creek graphite deposit located in eastern Ontario, and is well positioned to benefit from the favorable supply/demand outlook for graphite. Northern is the only graphite company to have completed a bankable Feasibility Study and has a large flake, high purity, scalable deposit that is located close to infrastructure with very competitive operating costs. Northern Graphite is one of the most well-followed graphite stocks on Seeking Alpha, with numerous articles discussing the stock.

In a recent analyst report from Mackie Research, the analyst placed a C$1.60 price target on the stock (current price C$0.65) saying that the stock offers investors leading exposure in the graphite space, as its advanced status will allow it to beat almost every other junior graphite company to production. In addition, the company's property, Bissett Creek, has a unique metallurgy that will allow for premier pricing and gross profit margins due to 100% of its product mix being higher value large flake material.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.