GrafTech International Ltd. (EAF) Earnings Call Transcript & Summary

Okay. We're going to keep moving along here. Next up, we've got GrafTech. GrafTech produces roughly 25% of the world's ultra-high powered graphite electrodes. It's essentially the key input for many metal-based steelmaking. You can't make steel basically without it. Additionally, GrafTech is the only UHP graphite electrode producer that is vertically integrated, owns its own petroleum needle coke facility. The Company came public in May 2018. Majority shareholder, Brookfield Properties, sold a piece of the company at that point. Presenting today from GrafTech is President and CEO, David Rintoul.

Thank you, David, and thanks to BMO for hosting us at their 29th Annual Global Metals & Mining Conference. Good morning, everyone. And thank you for your interest in GrafTech. So as usual, some of the matters discussed in this presentation today may include forward-looking statements regarding, among other things, results, performance and strategies. These statements are based on current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from those indicated by forward-looking statements are shown here. We will also discuss certain non-GAAP financial matters and measures, for which you will find reconciliations in these slides. These slides are posted on our website at www.graftech.com in the Investors section. For your reference, a replay of this webcast will also be available on our website. GrafTech is an industry-leading provider of graphite electrode services, solutions and products to the growing electric arc furnace or EAF steel industry. Graphite electrodes are a highly engineered, mission-critical consumable, primarily used for EAF steel as well as other ferrous and nonferrous metal productions. GrafTech produces high-quality graphite electrodes in 3 of the world's largest facilities: In Spain, France and Mexico. We are also the only graphite electrode producer that is substantially vertically integrated into petroleum needle coke, a key raw material for graphite electrodes, which has also seen increased demand as an input for electric car batteries. Vertical integration has allowed GrafTech to adopt a commercial strategy, including long-term, fixed price take-or-pay contracts, which help provide earnings stability and visibility. Thanks to our vertical integration and these long-term contracts, GrafTech has been able to generate substantial cash, free cash flow and has deployed that cash for shareholder returns and debt repayment. But before I continue, let's talk about safety for a moment. Health and safety excellence is a core value of GrafTech and is fundamental to everything we do. Our 2019 total recordable injury rate improved to 0.95, a 39% improvement from the prior year. The improvement we've made in safety is indicative of the work we're doing to drive continuous improvement across the entire company. As we enter 2020, we'll continue to work diligently to reach our ultimate goal of 0 harm. That means every worker going home safely every day. GrafTech has also delivered favorable 2019 financial results and operating results, including net income of $745 million, adjusted EBITDA of over $1 billion and free cash flow of over $740 million. At the same time, we continue to manage through somewhat softer market conditions. The World Steel Association reported preliminary 2019 global steel production, excluding China, was down just under 2% compared to the prior year. As we stated on our recent Q4 earnings call, graphite electrode inventories remain elevated for many customers. But we're seeing an early evidence that destocking is running its course. We continue to expect graphite electrode inventory destocking through the first half of this year and conditions forecasted to improve as we move into the back half of 2020. We believe these steel industry difficulties are short term in nature and will work themselves out over time. Longer-term trends remain positive for our business. Globally, EAF steelmakers continue to increase its share of crude steel production relative to integrated steelmaking. EAF steel production is advantaged in a number of ways: variable cost structure with an ability to shut off and restart efficiently with low fixed costs, lower capital intensity, lower initial capital with no need for extensive periodic relines as is the case with blast furnaces, and perhaps most importantly, more environmentally friendly. EAFs are the largest recycles in the world and produce significantly less greenhouse gas emissions than integrated steelmakers, some 75% less. Globally, 47% of steel produced via the electric arc furnace route in 2018 is up from 37% in the year 2000. And EAF is growing in almost every region, including, but not limited to, China, which has produced 108 million tons of steel via the EAF route in 2018, representing 12% of the overall Chinese steel production. In addition, the Chinese government has set a target to reach 20% EAF by 2025. This would imply EAF production of more than 180 million tons in China. India's EAF production increased to 60 million tons or 55% EAF in '18. And the Middle East is one of the highest growth regions, EAF steel production increased threefold to 23 million tons in 2018 and now makes up 96% of steel production in this region. Additionally, electric arc furnaces are continuing to make steady inroads in more mature markets such as North America, Europe and Asia Pacific. Another positive long-term trend for our business is incremental demand from needle coke from lithium-ion batteries. Needle coke is a primary raw material for graphite electrodes as well as used in the anodes for lithium-ion batteries in electric vehicle and other applications. The IAEA projects global annual sales of electric cars may increase from 2 million tons in 2018 to approximately 6 million in the current year 2020 and up to 33 million by the year 2030. Over the same period, battery size is also expected to increase due to the demand for larger, more powerful engines, particularly in the United States. Based on the IAEA estimates for electric vehicle sales and battery size and management estimates for needle coke used in anodes, demand for needle coke from electric vehicles could grow significantly from about 58,000 tons in 2018 to over 200,000 tons in 2020 and onward to 750,000 tons by 2025. As such, GrafTech's substantial upstream integration into petroleum needle coke represents a significant competitive advantage. Our Seadrift facility in Texas is expected to produce the majority of our long-run petroleum needle coke needs, and the cost to produce needle coke at Seadrift is significantly below recent and current market pricing. This vertical integration allows us to provide certainty of high-quality graphite electrodes supply to our customers and attractive margins for our shareholders. GrafTech has sold about 2/3 of our cumulative capacity via long-term take-or-pay contracts. The midpoint of these contracted values is 142,000 tons for 2020. As you can see here, we expect 2020 shipments under these contracts to be about 130,000 tons. That difference is driven by 2 factors: the first, we have fixed share contracts that make up as much as 5,000 tons of the difference. 5,000 tons of the fixed share contracts which are customers who typically buy 80% to 100% of their graphite electrodes from GrafTech. These contracts, which make up about 15% of our total contracts, allow a range of volume depending upon the customers' capacity utilization. The remaining difference is split between customers who are experiencing financial and/or operating challenges. In most cases, we expect the parties will work in good faith to implement the contract as intended. In a few other cases, we will seek formal remedies as provided by the contracts. With low-cost needle coke production and long-term contracts, GrafTech has a strong track record of free cash flow generation. In 2019, GrafTech generated nearly $750 million of free cash flow. In terms of uses of cash, approximately half of our free cash flow or $360 million was returned to shareholders through dividends and share repurchases. We also repaid $350 million of debt during that time. Shareholder returns and debt repayment are expected to remain the key priorities for uses of cash. Since our IPO, we have reduced debt by 18% and repurchased more than 11% of our shares outstanding. In 2020, we plan to use about 50% to 60% of our cash for debt repayment with the balance earmarked for shareholder returns. This enables us to manage our debt levels in line with the duration of the long-term contracts, while continuing to return cash to shareholders. We also continue to invest in our business. In 2020, we expect capital expenditures to remain at the $60 million to $70 million range, allowing us to maintain our high-quality, low-cost asset base. Capital expenditures are focused on high return, quick payback projects to reduce operating costs, increase productivity and develop products that our customers value. In addition, we will continue to invest in health, safety and environmental performance. Shareholder returns are expected to include primarily our regularly -- regular quarterly dividends and share repurchases. The timing of future share repurchases will depend upon share price, trading volumes and other market conditions. In conclusion, GrafTech is a leading provider of high-quality engineered graphite electrode services, solutions and products to the growing EAF steel market. The company benefits from substantial vertical integration and profitable long-term contracts. We have a proven record of generating cash and returning cash to shareholders and reducing debt. Again, thank you for your interest in GrafTech, and now I'd be happy to take your questions.

Great. Thank you. Do we have any starters from the floor? Few hands here.

How long do your contracts go out for?

I'm sorry, how long -- what?

Do your contracts go out for?

How long do the contracts extend out? Is that the question?

Yes, yes.

How long...

Do your contracts extend?

Okay. Most of the contracts were originally 5-year contracts, and we're through 2 years. So the bulk of them have 3 years remaining, including the current year.

On that. I don't know your business well, but I understand the kind of contracts with some of the coal industry in, just, uranium. When will you start renegotiating the new contracts if they're 3 years out? What kind of...

So we still have 3 years to go in these contracts. And look, these contracts are very much like hedging. So I would expect there will be another 1.5 years to 2 years before we would engage in another round of discussions around new contracts. We have a few discussions with a couple of large customers at the moment that want to extend them. Those aren't complete yet. It's basically going to be at their call. We're willing to do those kind of things. And it will be at their call as to whether they choose to do that or they wait till the end of the 5-year period.

With pricing coming off, everyone's waiting, I guess, to see what will happen with the new round of contracts. How would you comment on -- I know it's a long time away from now, but I guess you're waiting for -- hoping for a rebound in the pricing and...

Well, look, if you look at the current market situation and study the steel industry because, obviously, we serve the steel industry, so the things that affect the steel industry ultimately come to affect us. And one would say that -- or could argue that we've entered into the downward part of the cycle in the third quarter of last year. You could also draw a conclusion that over the last several weeks, there's some indication that -- whether it's hot-rolled pricing, rebar prices, Black Sea billet, scrap, et cetera, et cetera, there's some indication that the steel industry is beginning to be in the infancy stages of a recovery, having bottomed out. All that being true, we would expect, and I think you'll hear it in our earnings release, that we expect the second half of the year to be better than the first half. And when we look at the destocking that we know of electrodes in customers' plant, it kind of supports all of that. So we do believe, as we go into the end of this year and into next year, we'll see the market in a better place. And obviously, when you're in a better place, that's a more favorable time to be talking about those kind of things. But be that as it may, the point I think is important is these long-term contracts are hedging. So whatever the market's at, at the point in time when we go to renew, that market will dictate what the price of the hedge is, no different than if you were hedging natural gas or electricity or any other product that is hedged. So that's the way we view it. And at the time that the contracts are mature and come to fruition, we'll be negotiating new ones on the basis of wherever the market is at that time.

Can you spend a little time talking -- you had some charts on the needle coke demand. Can you talk about what you see on the supply side, given that robust growth? And then also, I think you've talked about your long-term cash cost, given your vertical integration for the vertically integrated tons, I don't know, $2,700, $2,800 a ton. As we think about beyond '22 and your long-term profitability, can you talk about where you see the higher end of the cost curve? Is that -- where do you view as a floor to electrode price as a function of the high end of the cost curve for electrodes?

So in terms of our cost curve, we have the great benefit of being vertically integrated. So we have a control over our own raw material costs. And I think as Quinn alluded to on the call -- on the earnings call and you quoted that number of around $2,800, that's all-in for our cost structure with our own needle coke. In terms of cost changes over the next number of years, I think our expectation is they would be in line with inflation because we have control over that entire structure. We're not beholden to a third party that can change things that we don't have control over. So we don't expect outside of a normal inflation adjustment, a great deal of change in our cost structure.