GrafTech International Ltd. (NYSE:EAF) Q3 2023 Earnings Call Transcript

GrafTech International Ltd. (NYSE:EAF) Q3 2023 Earnings Call Transcript November 3, 2023

GrafTech International Ltd. misses on earnings expectations. Reported EPS is $-0.08 EPS, expectations were $-0.05.

Operator: Good morning, ladies and gentlemen, and welcome to the GrafTech Third Quarter 2023 Earnings Conference Call and Webcast. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Friday, November 3, 2023. I would now like to turn the conference over to Mr. Mike Dillon, Vice President, Investor Relations and Corporate Communications. Please go ahead, sir.

Mike Dillon: Thank you. Good morning and welcome to GrafTech International’s third quarter 2023 earnings call. On with me today are Marcel Kessler, Chief Executive Officer; Jeremy Halford, Chief Operating Officer; and Tim Flanagan, Chief Financial Officer. Marcel will begin with opening comments. Jeremy will then discuss safety, the commercial environment, sales and operational matters. Tim will review our quarterly results and other financial details and will close with comments on our outlook. We will then open the call to questions. Turning to our next slide. As a reminder, some of the matters discussed in this call may include forward-looking statements regarding, among other things, performance, trends, 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 measures, and these slides include the relevant non-GAAP reconciliations. You can find these slides in the Investor Relations section of our website at www.graftech.com. A replay of the call will also be available on our website. I’ll now turn the call over to Marcel.

Marcel Kessler: Good morning, everyone. Thank you for joining GrafTech’s Third Quarter Earnings Call. I will begin by summarizing three key points we will discuss in more detail on our call today. First, the global steel industry remains constrained by geopolitical conflict and economic uncertainty, which has resulted in a persistently soft — within a persistently soft commercial environment and weak demand and declining prices for graphite electrodes. As a result, our performance for the third quarter fell short of our expectations and our outlook has weakened. Second, GrafTech remains focused on managing through the near-term market disruptions while maintaining our positioning for long-term opportunities. We recognize steel industry performance and demand for graphite electrodes will be dependent on macro conditions.

As such, we continue to prioritize those things that are within our control. These include proactively reducing our production volume to align with our near-term demand outlook, closely managing our operating costs, capital expenditures, and working capital levels, and making targeted investments to further improve our operational flexibility and support long-term growth. Our ability to execute these strategies is evident in the strong cash flow generated in the third quarter. Supported by these actions, we remain confident we have ample liquidity between cash on hand and borrowing availability to weather the market challenges. Third, we remain optimistic about the long-term outlook for our business and our ability to deliver shareholder value.

We are taking actions that we believe will optimally position GrafTech to benefit from longer-term industry tailwinds in our graphite electrode business. At the same time, we continue to advance our efforts toward participation in the development of a Western EV battery supply chain. And you remain excited about this opportunity. Jeremy and Tim will expand on all these points during the call today. Before I turn the call over to them, I would like to address the recent announcement that I decided to resign from my role as CEO and President of GrafTech due to family health reasons effective later this month. During my first call after joining the company, I spoke to the reasons why I was attracted to GrafTech. A set of distinctive capabilities that provide confidence in our ability to deliver shareholder value over the long term.

A business that is well positioned to participate in the long-term growth of the electrode market and with a promising foundation to pursue other avenues of growth. And a team with an impressive level of know-how, energy, and dedication. I feel that all these attributes are still in place today, and I continue to believe that GrafTech has some of the industry’s best assets, operated by the best people and will get through this challenging period to remain an industry leader. We remain confident in the long-term direction of the company and the experienced management team that remains in place to execute our strategies. With that, let me turn the call over to Jeremy.

Jeremy Halford: Thank you, Marcel, and good morning, everyone. As always, I’ll start my comments with a brief update on our safety performance, which is a core value at GrafTech. We are pleased that our year-to-date recordable incident rate reflects a substantial improvement from the prior year level. As I noted at the beginning of the year, improvement in this area would be a key point of emphasis with our internal teams in 2023. And I would like to thank all of our team members for their ongoing efforts. We will remain highly diligent in this area and seek to further improve this metric as we continue working toward our ultimate goal of zero injuries. Let me now turn to the next slide for an overview of macro conditions and the commercial environment as context for our third quarter results and our outlook commentary.

Steel industry production remains constrained by lower demand due to global economic uncertainty. Across the industry, there continue to be announcements of planned and unplanned outages at steel price. At the same time, steel exports from China in 2023 are on track to reach a seven-year high as China’s domestic demand for steel has not been strong enough to absorb the year-to-date 2% increase in Chinese steel production. These trends are reflected in steel industry output levels outside of China that remain below the prior year with most regions showing production decline. Looking at the numbers, on a global basis, field production outside of China was approximately 201 million tons in the third quarter of 2023. This represented a 4% sequential decline from the second quarter.

On a year-to-date basis, global steel production outside of China was down 2% year-over-year through the first nine months of 2023. Regarding global capacity utilization, the rate outside of China declined sequentially to 65% for the third quarter. On a regional basis, the economic performance and outlook for key regions continues to diverge. In Europe, the ongoing slowdown in industrial production, subdued market demand, and high energy costs continue to weigh on steel production. And reflecting weak macro fundamentals, the persistently low levels of economic growth within Europe are expected to continue for the foreseeable future. Two weeks ago, the World Steel Association issued their latest short-range outlook, noting they expect a 5% decline in EU steel demand for 2023 as compared to their previous projection in April of demand being flat.

World Steel also reduced their 2024 steel demand forecast for the EU by 4% compared to their April forecast. In the US, although the region is showing more resilience, steel industry trends have softened of late. Utilization rates ticked down slightly in the third quarter to 76% and declined further in the first few weeks of the fourth quarter. In their recent outlook update, World Steel forecast a 1% decline in year-over-year steel demand in the US for 2023, compared to their previous forecast of 1% growth. They also lowered their 2024 outlook by 3%. Overall, a significant amount of global economic uncertainty remains an overhang on steel industry demand in the near term. This, in turn, has resulted in ongoing softness for graphite electrode demand.

Along with the soft demand, additional competitive dynamics are having a significant impact on pricing. Specifically, despite the current weak market environment, we continue to see a healthy level of electrode exports from certain countries, including India and China. These are typically lower priced electrodes, and their prices have been declining further of late. For example, based on the latest reported statistics, export prices from China have fallen below $3,000 per metric ton on average. These export dynamics are having a significant impact on pricing in non-tariff protected regions, such as the Middle East, that are typically an important element of our portfolio. In addition, there can be knock-on pricing effect in tariff protected countries, such as within the EU, as Tier 1 producers increasingly compete in these regions to support volume.

With that background, let’s turn to the next slide for discussion on GrafTech’s third quarter performance. Our production volume for the third quarter was approximately 23,000 metric tons. This resulted in a combined capacity utilization rate for our three primary electrode facilities of 47% for the third quarter compared to 49% in the second quarter. Our manufacturing operations continue to run according to our strategy of proactively managing production volume to align with our evolving demand outlook. In the third quarter, sales volume was approximately 24,000 metric tons. This represented a modest decline compared to the second quarter and fell short of the outlook we provided on the last call, reflecting the market conditions I just spoke to.

Shipments for the third quarter included nearly 8,000 metric tons sold under our LTAs at a weighted average realized price of $8,650 per metric ton. And 16,500 metric tons of non-LTA sales at a weighted average realized price of $5,400 per metric ton. The weighted average price for non-LTA sales was below the second quarter level, reflecting a soft commercial environment. Net sales in the third quarter of 2023 decreased 48% compared to the third quarter of 2022. In addition to the lower sales volume and lower pricing, the ongoing shift in the mix of our business from LTA to non-LTA volume contributed to the year-over-year decline. We expect the commercial environment and demand for graphite electrodes in the near term will remain weak. The decline in steel production and utilization rates outside of China have limited the ability of customers to significantly drive down their electrode inventory to typical levels.

Given these dynamics, we anticipate our sales volume for the fourth quarter will decline modestly compared to the third quarter. Against this backdrop, we have begun the negotiation process for 2024 electrode sales and are developing a range of commercial offerings that are intended to contribute to an increase in capacity utilization. Although it’s too early to project opposition to our customers, including a strategically positioned manufacturing footprint that provides operational flexibility to reach key steelmaking regions, being the only large-scale graphite electrode producer that is substantially vertically integrated into petroleum needle coke, offering access to the architect furnace productivity system and customer technical services at no incremental cost to the customer, the ability to produce connecting pins at three different locations on two continents and reflecting some of the targeted investments we’ve previously referenced, we anticipate an expansion of our product offerings as we proceed through 2024.

This includes adding 800-millimeter supersize electrodes to our portfolio to serve a small but growing segment of the UHP graphite electrode market. And in addition, we expect to bring to market the industry’s first carbon neutral graphite electrode offering. As always, our focus remains on producing the highest quality graphite electrodes and meeting the needs of our customers. For these reasons, we continue to believe GrafTech will remain an industry leading supplier of mission critical products to the electric arc furnace industry, the fastest growing segment of the global steel supply chain. Let me now turn it over to Tim to cover the rest of our financial details.

Tim Flanagan: Thanks, Jeremy. For the third quarter we had a net loss of $23 million, or $0.9 per share. Adjusted EBITDA was $1 million compared to $129 million in the third quarter of 2022. The decline reflected lower sales volume, higher year-over-year costs on a per-metric basis, the continued shift in the mix of our business toward non-LTA volumes and lower pricing. As Jeremy spoke to a number of these factors in his remarks, I’ll expand my comments on costs. We provide a reconciliation of our cash cost per metric ton in the earnings documents posted on our website. However, let me provide some additional color. Reflecting the full year impact of raw material, energy, freight cost increases that occurred throughout 2022, we continue to sell higher priced inventory during the third quarter of 2023.

In addition, during the quarter, our cash costs included approximately $18 million of fixed costs that otherwise would have been inventoryed if we were operating at normal production levels. This compared to approximately $10 million of such costs recognized in the second quarter. The sequential increase was driven by two factors. First, a modest quarter-over-quarter reduction in graphite electrode production. Second, and more significantly, was the impact of temporarily idling needle coke production at our Seadrift facility throughout the third quarter. As we previously noted, we have been taking a proactive measure to align our production with our current demand outlook. The temporary idling of production at Seadrift was consistent with this approach.

These actions have provided meaningful benefit to our working capital levels and cash flows. Factoring all of this in, our cash COGS per metric ton were approximately $5,860 for the third quarter of 2023. This exceeded our projection for the third quarter, reflecting the impact of the previously discussed volume shortfall as underlying costs coming from inventory were largely in line with our expectations. Looking ahead, we expect our cash COGS per metric ton in the fourth quarter of 2023 will be below the recognized level in the third quarter of this year, but will be above our previous expectations. Market pricing for our key elements are cost structure, including decant oil, energy, coal tar pitch and freight, continue to moderate as expected.

However, the decline in our volume outlook has a two-pronged effect on the cash COGS per metric ton that will be recognized in the fourth quarter. First, with the lower sales volume, this extends the time it takes to work through the higher price inventory on our balance sheet. Second, with the corresponding decline in the production volume, we will continue to recognize in the current period fixed costs that otherwise would be inventory if operating at normal production levels. Specifically as it relates to Seadrift, we expect to restart the facility in the fourth quarter, which would result in a modest sequential reduction in the level of fixed cost being recognized on an accelerated basis. Turning to cash flow. For the third quarter, we generated $51 million of cash from operating activities and adjusted free cash flow of $43 million.

This cash flow performance was supported by our ongoing focus of managing our costs, capital expenditures, and working capital levels. Most significantly, this included a $50 million reduction in inventory during the quarter. We continue to expect adjusted free cash flow to be positive for 2023 on a full year basis. As we look further ahead, from a cost and cash flow perspective, we expect market pricing to decline in the medium to longer term for certain key elements of our cost structure. We will continue our current disciplined approach to managing costs and working capital. These actions have resulted in a 12% reduction in our period costs for the first nine months of 2023 compared to the same period in the prior year. In addition, since the end of 2022, we have reduced our working capital levels by $65 million as of the end of the third quarter.

Our decisions and actions in this area continue to be informed by three key and complementary objectives. One, our focus on preserving cash and maintaining sufficient liquidity as we navigate the current market uncertainties. Two, while doing so, continuing to ensure that we remain well positioned from a working capital perspective to meet the evolving needs of our customers. And third, continuing to make targeted investments to support our ability to capitalize on the long-term growth opportunities. We are proud of the agility of our teams have displayed in balancing these essential priorities. I believe these efforts have positioned as well to benefit as the markets recover. I want to thank the entire GrafTech team for their continued efforts and commitment.

Moving to the next slide. Our net debt to adjusted EBITDA ratio is 6.4 times as of September 30th compared to 1.5 times at the end of 2022, reflecting a year-over-year decline in EBITDA for the first nine months of 2023. As of September 30, our liquidity was $285 million, consisting of $173 million of cash on hand and $112 million of availability under a revolving credit facility. This reflects the financial covenant that limits our borrowing availability under our revolver in certain circumstances. However, more importantly, we do not anticipate the need to borrow against revolver in 2023. Further, we remain confident we have ample liquidity between cash on hand and borrowing availability to achieve the priorities I just spoke to. Turning to the next slide, let me now expand on the actions we are taking and the investments we are making to improve our strategic positioning for the long term.

Decarbonization efforts are driving a transition in steel, with electric arc furnace steel making continuing to increase its share of total steel production. With this trend, in EAF share growth expected to continue, we anticipate demand for graphite electrodes to experience accelerating growth over the longer term. We estimate that planned EAF capacity additions based on steel producer announcements, along with production increases at existing EAF plants has the potential to bring an incremental 200,000 metric tons of annual graphite electrode demand outside of China by 2030. This would represent nearly a 30% increase to the level of global annual graphite electrode demand in 2022 outside of China of approximately 680,000 metric tons. In addition, the demand for petroleum needle coke, the key raw material we use to produce graphite electrodes is also expected to accelerate.

This is driven by its use to produce synthetic graphite for the anode portion of lithium ion batteries used in the growing electric vehicle market. Based on analyst estimates regarding projected growth in electric vehicle sales and battery pack sizes, we estimate that the result in global needle coke demand for use in EV applications increasing at a compound annual growth rate of over 20% through 2030. The growing demand for needle coke should result in elevated pricing for this important precursor material. Given the high historical correlation between petroleum needle coke pricing and graphite electrode pricing, this trend should translate to higher market pricing for electrodes. Reflecting our sustainable competitive advantages and the key elements of our customer value proposition which Jeremy spoke to, we are well positioned to capitalize on these favorable industry tailwinds.

We also see potential long-term value creation opportunities by participating in the anticipated growth of the EV battery market. To that end, we continue to study participation via two potential avenues. First, by leveraging our assets and technical know-how in the area of petroleum needle coat production given the expected demand growth for this key raw material. Second, by leveraging our graphitization resources and expertise to produce synthetic graphite material for battery anodes. While we have not yet made any firm commitments, the pace of our activity in both areas continue to accelerate. In addition, we remain encouraged by the external market developments in the space, which continue to evolve rapidly. As an example, last month China, the country that currently supplies nearly all the anode material for the world, announced a curve on exports of synthetic graphite.

While it’s too early to speculate on the ultimate impact this measure will have, we view this as another positive reinforcement of the importance of this key raw material for battery anode production. Further, this also reinforces the importance of the industry building a robust supply chain outside of China as we move forward. We are excited about the opportunity to participate in the development of a Western EV battery supply chain as we possess key assets, resources, and know-how to support this industry. We look forward to sharing more as we can. In closing, our optimism remains intact. We are an industry-leading provider of the consumable product that is mission critical for the growing electric arc furnace method of steelmaking. We possess a distinct set of assets, capabilities, and competitive advantages.

Lastly, as a result of our disciplined capital allocation strategy, we have a strong balance sheet and ample liquidity that navigate the near term. For these reasons, we are confident in our ability to deliver shareholder value moving forward. This concludes our prepared remarks. We’ll now open the call for questions.

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Q&A Session

Operator: Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] We have our first question coming from the line of Arun Viswanathan from RBC Capital Markets. Please go ahead.

Arun Viswanathan: Great. Thanks for taking my question. Good morning. Maybe I can just start with the electrode market outlook. So, it sounded like you had noted that there was continued price pressure and maybe some spot pricing data points around $3,000 a ton. Did I hear that correctly? And I guess what do you expect as far as how that evolves? I mean, is that mainly just weak seasonality and weakness in the China market that’s causing that — those declines? And do you see that maybe reversing and going back higher in early 2024, or how do you think about electrode pricing from here?

Jeremy Halford: Yeah, so as we mentioned, Arun, Q3 non-LTA pricing was weaker than Q2 driven by the softer commercial environment. And we also noted that in the near term, as we reference from the World Steel Association statistics, we expect continued market weakness and with that, continued competitive pricing dynamics. With specific regard to the $3,000 Chinese pricing, that of course affects us much more in non-tariff protected regions than it does in the tariff protected regions that we referenced. And going beyond that, given that we’re in the middle of our negotiation season with the customers, it’s probably a little too soon to provide any more pricing guidance.

Arun Viswanathan: Okay. And what about needle coke then? So could you just provide us an update on where needle coke prices are and what do you expect on that side as well?

Jeremy Halford: Yeah. So, looking at the import-export data, we’ve seen recent spot pricing for super premium needle coke in the range of about $1,700 a ton. There are some transactions below that, but that’s generally a number that we’re seeing. And this does reflect a little bit of further softening compared to what we indicated on the last call of around $1,800 for the higher end blend. But one of the things that I think is important to note is that, pricing here can be highly volatile, right? In the past we’ve seen — in the past years, we’ve seen pricing as high as $3,000 last year and below $1,500 the year before that. And so, really we think the recent declines in needle coat pricing are indicative of recent softness in the electrode market, not being fully offset by the growth that’s coming from the EV market. Longer term, as the EV demand materializes, I continue to expect the petroleum needle coke market to further tighten, leading to higher prices.

Arun Viswanathan: Yes, and that’s a good segue to another question I had, which was, do you think that there’s a greater sense of urgency now at GrafTech to pursue further opportunities for needle coke development and graphite development into the EV market, especially since China has placed some restrictions on their exports of graphite. Wouldn’t that combined with the market softness that you’re seeing in electrodes, really incentivize GrafTech to really make some more investments on that side and maybe accelerate your opportunities into delivering needle coke into EVs?

Jeremy Halford: I don’t know that we needed any more motivation to get into that room. This is something that we’ve been studying for quite a while, and we feel good about where we’re at, right? The industry is currently in the very early stages of its development of the Western supply chain. And as part of that, we’ve been very active proactively testing our needle coke with third parties and potential customers to make sure that it meets the quality standards and specifications that are required. With regard to concerns about the China announcement, I think Tim captured a lot of that. It’s too soon to know exactly what this is going to mean, but we do think at a minimum, it’s a positive reinforcement of the importance of synthetic graphite for battery anode production.

And more importantly, it reinforces the importance of building a robust Western supply chain rather than depending on China. And so, if this was not already apparent to OEMs and cell manufacturers before, it’s certainly top of mind now.

Marcel Kessler: Yes, and I would add to that a room. I think the EV opportunity is an exciting opportunity that we’ll continue to explore and do the work we need to, as Jeremy has outlined. But we still have a strong conviction around the core business of graphite electrodes and what that market will look like. Obviously, conditions aren’t great right now. It’s a cyclical business, and we’re in a bit of a down stroke as we sit here today. But we’ve seen pricing move very quickly. We’ve seen demand pick up very quickly. Any sort of material improvement in the macroeconomic environment, whether that’s in Europe, Chinese steel production, the overall Chinese economy, can have a pretty sudden and swift movement for the core business, which again, short term we see some challenges outlook wise, but longer — medium to longer term, we still have full conviction in the business that it’s here today.

Arun Viswanathan: Right, and how much of your production do you think you could divert to the EV market? And, obviously, I would imagine that would also include maybe an expansion at Seadrift. Could you just address those issues as well? Thanks.

Jeremy Halford: Yes, so one of the things that makes GrafTech an attractive partner in this space is that, we really do have almost dual-use assets. The same assets that we utilize to make needle coke for graphite electrode production, it can be used to make needle coke for anode production. Similarly, the graphitization assets that we use to make our electrodes can also be redeployed to make anode materials. And so, I don’t have a real percentage to offer, Arun, more. I think it’s — I think the relevant point is that our assets truly are dual use and we can select the most economically favorable [indiscernible] for the use of assets. Yes, so I was just going to add that with specific regard to your question about Seadrift, you’ll recall that last quarter we discussed having filed a permit for the potential expansion of Seadrift.