by Travis Johnson, Stock Gumshoe | October 3, 2014 8:25 pm
I have to warn you up front, after reading through this before sending it out to you I’m a little worried. You might think I’m a bit “off my meds” today — I didn’t have one coherent idea to share, so I ended up with a stream of consciousness that’s a jumble of ideas, ranting, and updates on companies that, I suppose, pretty well reflects the yo-yo nature of the stock market this week. If you want the short version: I still don’t like graphite, iron ore is a disaster for the same reason graphite is but I still like Altius, and I sold my Xerox shares. The rest is all over the place, but feel free to read on… hopefully it won’t feel too much like you got stuck sitting next to a drunk guy on the plane.
Much as I’ve felt inclined to slowly increase my cash position over the past year or so, I do find “high uncertainty” weeks like this incredibly enticing — when the market drops a couple percent and stocks I keep an eye on are falling by 5-10%, like many did on Wednesday and Thursday, it’s hard to resist scooping them up.
Yes, I know the old saying that we should avoid “falling knives” (though sticking strictly to that strategy is a little like walking through a store and saying “20% off? Meh! I bet on Black Friday it’ll be 50% off!”), but cheaper prices always catch my attention. I had a buy order in for a favorite insurance company stock for a while right about at its most recently reported book value, which I consider a very good price, and it finally triggered this week — so I own a few more shares of Third Point Re (TPRE), and I’m delighted to own those shares, despite the fact that the stock could easily fall further. But there were a dozen other stocks that I would have considered adding to if the markets didn’t bounce right back today with our job numbers, and I’m sure there are plenty of stocks I don’t own that will hit attractive prices next time the market freaks out a little bit.
Which is not to say that I’m going after every stock that is down, or even that I’m only buying (I sold Xerox today, more on that in a minute). I am not feeling compelled to go “all out” and buy up natural resources stocks that are getting hammered by the fall in oil prices or other commodities, for example, since those prices could certainly fall lower and I’m already pretty heavily weighted to that broad sector… but I might be tempted if this beating continues (that would include stocks that are highly levered and riskier, like Seadrill (SDRL), as well as services companies like TGS Nopec (TGSGY) or National Oilwell Varco (NOV) that are far less wild but still oil-related, as well as the actual oil explorers and producers).
And yes, for those who are invested in anything iron ore-related the weakness is pretty much a rout now — Cliffs (CLF) has been the poster child for that and has now fallen 90% in 3-1/2 years, both because of their own specific issues and, more, because of falling iron ore prices, so there’s rarely a rush to “bottom fish” in extremely volatile commodity industries. You’ve probably heard the old joke…
Q: What do you call a stock that fell 90%?
A: A stock that fell 80% and then got cut in half.
I harp on this point from time to time, but if your underlying assumptions are wrong, and a company is very levered to on one particular outcome, then it’s important not only that you think about the possible implications but that you don’t lever your portfolio to a lot of seemingly different companies who rely on the same levers. That’s not diversification. So, for example, if you buy an iron ore miner because of the value of its reserves or cash flow, and also buy a dry bulk shipper because of its dividend, keep in mind that if China imports less iron ore then both of those investments will stink at the same time. And sometimes, even a stock that you might think of as a high-tech idea will be driven down by the same thing that’s hurting iron ore companies (more on that in a minute, too).
Even more broadly speaking, I know that a lot of investors are so disenchanted with the Federal Reserve and fractional banking that they put all of their money into “hard assets” — that’s a reasonable and logical argument, since hard assets should hold their value if the dollar falls, but it has also destroyed a lot of portfolios, at least temporarily.
That’s because so far, and through several years of these predictions, the dollar’s not falling even as the Federal Reserve tries to inflate… much to the chagrin of Ford (F) and the other multinationals who would love to be able to export more cheaply. And the traditional “hard assets” of real estate, commodities, and precious metals are not the only things that will hold value if the dollar does, in the end, resume its long, usually slow devaluation through inflation.
We have another wave of folks predicting that the end of “easy money” from the Fed as Quantitative Easing ends and as chatter about rising interest rates comes to the forefront will crash the dollar, whether because there are no buyers for the buck after the Fed steps out, which certainly hasn’t been true so far, partly because people are desperate to get out of the Euro and Yen, or because everyone panics when China announces they’ve cornered the gold bullion market (Alan Greenspan had a brief piece about that last week in Foreign Affairs, far less inflammatory than the pitches about China’s secret hoarding creating a crisis point). That kind of fearmongering has always sold newsletters, but the predictions about the demise of the dollar and the “end of our way of life” have been wrong for 40 years… that’s why those predictions have to be “rolled up” to a different catalyst point each time they’ve been wrong, so it’s China’s gold announcement in April that will cause a crisis (didn’t come) or the enactment of FATCA in July that will cause a crisis (might have helped to hurt the market, I suppose, but it sure didn’t help hard assets), or whatever the next logical date might be now that those have passed.
I agree that our debt-fueled economy is unsustainable, but it was also unsustainable in 1982 — predicting the macro moves of economies and governments is a great way for individual investors to lose money and pay huge opportunity costs as they miss out on the (inflation beating) performance of the stock market. That kind of thinking can give a feeling of world-view certainty that colors everything you do with your portfolio, and having a portfolio built around specific macro predictions… particularly time-constrained ones… is a good way to shrink a portfolio. Almost no one is going to get macro moves right even over five year time periods, let alone the weeks and months that constitute “long term” for the investor with the itchy trigger finger.
Yes, there has been inflation — often pretty high inflation — and the Fed is working really hard to get inflation back, so it might well be that we get terrible inflation at some point, or severe economic stagnation if the debt-fueled global (and especially U.S.) economy loses the confidence of consumers and investors. But absent a catastrophic crash in the economy that kills businesses, the solution to inflation is… put your money to work. Productive assets like good businesses should rise in value with inflation, and they should spin off more cash to help counter the wealth-destroying impact of inflation. That’s why a Harvard Education may cost 100X what it did a century ago, and a comic book may cost 50X more than it did in the 1930s, but salaries have also risen 50 or 100-fold in nominal terms. Those who bear the brunt of inflation are the people who are stuck with those nominal amounts they started with — they either lend money at fixed rates, or don’t do anything at all with their cash and just stuff it in the mattress. That’s the only thing that I’m pretty sure will be unsuccessful for the next 20 years.
I own some real estate and some commodities stocks, and I buy a little silver and gold from time to time as a hedge against a future where the dollar is less valuable — but unless you believe that modern economies will truly grind to a halt and you’ll really need to farm your own land and barter for seeds, there’s every chance that great businesses who own unique or hard-to-replace franchises and generate good or growing profits from products and services that are genuinely in demand will do very well regardless of whether the Dollar advances versus the Euro or the Yen or versus gold or silver. If you bet your portfolio on the collapse of the modern economy, there aren’t a lot of other ways for you to win… or to compound earnings or grow your cash flow if you’re not precisely right.
So what does one do? Well, it’s always good to keep a list of excellent stocks that you want to own at hand — that way you’ll know which ones to check in on if and when the market falls by 20% and everyone is in a panic. There’s not usually a rush, downturns are not typically quite so abrupt as the “flash crash” of a couple years ago and we typically have plenty of time to buy stocks both on the way down and on the way back up if they look attractive… but if you have that list easily at hand it will help you, at least a little bit, to have the mindset to take advantage of down days to buy strong companies that you think you’d like to own for 20 years if you could just get the “right” price… it’s not a crash, it’s that opportunity you never thought you’d see to buy (KO, MCD, ADP, MMM, GOOG, whatever) at a discount price.
I wish I’d had such a list in 2009, because at the time I found myself way too caught up in the downturn and in looking for safety and protective positions — which was exactly the wrong thing to be buying when everyone else also thought the world was ending. I did make some good buys back in 2008 and 2009, but I also did some stupid selling and missed a great number of opportunities because I was far too blind to the opportunities we were presented to buy GOOG at $150 or MMM at $40 or SBUX at $10 or whatever. And those aren’t just examples, those are stocks I looked at then and didn’t “pull the trigger” to buy because I was being overly cautious.
Managers who are investing other peoples’ money may have good reason to panic in a downturn — they may have to give the money back, and they are measured against the index every day so all they have to do is make sure they lose less than the market… which is easy to do if you hold cash. But if you’re investing your own money and you’re looking at building your portfolio for decades to come, you have great advantages that professional managers don’t have — you don’t have to measure yourself against the market, you just have to fight through your own panic and try to dispassionately think about the future with a bit of discipline. I wish I could tell you I was great at it, I’m not, but I hope that the more I type those words “cheaper prices may be an opportunity, not just a calamity” the less I will freak out next time someone’s hair is on fire on CNBC.
So yes, headlines were scary this week before the world got all rosy again, and neither extreme is probably useful — “Investors Batten Down Hatches” and “End to Easy Money” and “Phew! Job Creation Shows Rebound” and “Unemployment Lowest in 6 Years.” And my portfolio was down a good 3% or so on the week at one point.
What should I do? I am moving more cash into my brokerage account, because I fully expect to have some good places to put it in the volatile weeks to come… whether that means stocks I already own or follow will get cheaper, or I’ll be lucky enough to buy those “wish I owned it” stocks at a bargain price, and whether that happens this week or next month or next year, I don’t really know. I get a little churn in my stomach when the market seems to be on the verge of crashing just like everyone else, but I hope to be able to turn that queasiness into some greedy buying. So far, those who have feared the lofty prices in the market and have been patient and waited for a pullback have been disappointed — every time the market has fallen by 5% or so in the last two years, it has bounced back almost immediately and resumed the bull market uptrend. Will that happen with this latest mini swoon? Well, given the eagerness of folks to buy back in after the better-than-expected unemployment report today, I wouldn’t bet against it.
So I’m not doing anything big. I’m selling a little and buying a nibble here and there when things look inexpensive to me, as with TPRE this week, but I am still keeping my cash balance unusually high at 5-10% at the moment partly as an indication of how few things look cheap and appealing at today’s prices. Anything much over 1% in cash in my brokerage accounts is high for me — I’m not a trader and I don’t put my savings in my brokerage account, that’s in, well savings accounts and similar vehicles, with a small allocation to precious metals… my brokerage accounts are for money that’s supposed to be doing something productive. And I’m still working, thanks to you folks, so I’m still trying to keep adding money to my brokerage accounts — with the hope that I’m at least a couple decades away from having to pull it back out.
That does not mean I’m doing nothing, though often “don’t do something, just stand there” is really the best advice for individual investors — more action means we have many, many more chances to make mistakes, and the herd mentality that would have us sell at the bottom and buy at the top is extremely hard for most peoples’ brains to fight.
I did sell my Xerox shares today, as I’ll explain more in a moment, and I’ve been, well, thinking. I’ve been thinking about adding a bit to my REIT exposure, despite the fact that everyone is a bit worried about the Fed starting to raise rates in the first half of next year — as I think I’ve made clear, I think the very slow rise in rates that’s most likely is a non-event for good REITs. At this point, I’ve been considering adding a bit to my timber position, probably by adding some Weyerhauser (WY) to supplement my Rayonier (RYN) holdings, and I’ve been waiting to see how whether and how much Medical Properties (MPW) and CoreSite (COR) raise their dividends in the fourth quarter to determine whether I want to overweight them any more in my portfolio — COR is a dividend growth story at heart so it’s really a question of how much they hike the payout, but MPW has yet to really prove itself a grower (they’ve only raised the dividend once in recent times, a year ago in December, which was my first signal to get in with a substantial position).
Recently I’ve been considering selling Xerox as a way to keep myself to a buying/selling discipline.
Why sell? Well, because XRX was dirt cheap and doing buybacks at less than book value a couple years ago when we got in, but now it’s at closer to an average multiple, trading above book value, and it’s faced with some substantial business challenges including troubled healthcare IT projects, and it’s not likely to grow much — probably no real revenue or earnings growth this year or next year, despite the rapid growth in some of their segments (like healthcare system management).
So the company looks pretty steady, but at this point is mostly a capital allocation and dividend growth story… there are better stories of that ilk, and Xerox has had some blow-ups over the years (including big ones in 2011 and 2012, as well as the 20% drop early this year) that mean we probably shouldn’t have a lot of faith in perfect execution. Xerox is a company that was not as bad as it looked when the stock fell to $6 or so early in their turnaround a couple years ago, but it’s probably also not as predictable and stable as it looks right now — it’s still a company with a declining high-margin hardware business and a slow-growth lower-margin services business that’s smack dab in the middle of some extremely competitive markets, going up against IBM and the like. They also just made a small acquisition today, of another public-sector software company that looks like it’s designed to help XRX shore up some of their offerings in health insurance and human resources management for governments — they didn’t disclose the cost of the deal, it was presumably quite small (Consilience, the company they acquired, was private — Hoover’s indicates they had sales of just $6 million and only 35 employees, which may be out of date, but likely still small).
On the flip side, I HATE to sell dividend growth stories or good dividend payers. And Xerox does have a culture of innovation and (recently) good management and they have been very shareholder friendly in recent years, getting the dividend growth going and buying back a ton of stock. They have been filing tons of patents, as they have for years, and they are actively transitioning the business to higher end services and document/workflow management… I just don’t look at them as having much growth potential. The business is flattish, and we’ve had our 50%+ gain in 18 months, so do we get out and book some profits or just let it ride and compound?
My decision? I’m going to sell, because I think I’ll have better places to put that cash before too long and I don’t see great opportunities for Xerox to become a much better company in the next year and a half. And because I’ve never thought Xerox was a spectacular company — I thought it was a safe and very undervalued stock. It’s not undervalued any more, not in my book, so I’ll accept the value investor precept that if you are going to buy something mostly because it’s cheap, you need to sell it when it’s not cheap anymore (or, as other folks have put it, don’t change the reason you bought the stock just because you don’t feel like selling).
I expect Xerox to be a steady but below-average stock going forward, with any earnings growth coming solely from stock buybacks (they’re not increasing earnings, but they might slightly increase earnings per share because of buybacks), and it’s not urgent for me to sell the shares … but with their current and expected performance I wouldn’t want to buy them unless the stock was down around or below $10 again. Those who are more patient than I might want to just keep riding it, with the anticipation that they might indeed become the “next IBM” in another decade… in which case, it might be worth trading around the position with options to get a little more bang for your buck (ie, selling covered calls to earn a few more percent), or setting a tight stop loss if you’re as ambivalent about the shares as I am at these prices. A 20-25% trailing stop loss (accounting for the $14 highs earlier in the year) would have folks who stick to a mechanistic strategy like that selling if it drops to around $11. I’ll take $13 and change instead, since I think $15 is unlikely in the next year. And if I’m wrong, well, I’m wrong with a 50% profit already taken — I can live with that.
Xerox has been resilient compared to the natural resources stocks I own, though, which is part of the reason that I’m more willing to sell it — I don’t need just resilient ballast in my portfolio (though there’s an argument for that), I need things that I can buy cheap that will either rise in value as their business improves, or spin off good cash dividends. Buying things that are cheap is a good way to give yourself a better chance of that “rise in value” part, but, as we’ve seen with lots of the natural resources stocks, it’s important to question your assumptions.
One of my larger mistakes in the big picture over the last year or two has been my assumption that China’s steel demand will stay pretty high, and therefore that iron ore demand would remain strong, albeit lower than during the boom times of 5-10 years ago. That’s a substantial part of the story underlying both MFC Industrial (MIL), which has a couple key iron ore projects, and Altius Minerals (ALS.TO, ATUSF), which until a year ago was almost entirely levered to iron ore because of its spun-off Alderon (AXX) investment and the associated royalty on the Kami iron ore mine which was just about to get the green light for development.
That doesn’t mean I’ve changed my mind about Altius, which is a major holding, or MFC Industrial, which is a minor one — but it means that particular bit of “optionality” is now essentially worthless at both of those companies.
What do I mean by “optionality?” It’s a term that investors throw around a lot when they’re valuing a stock. There are different ways of thinking about it, but in this case I mean that Altius and MFC have multiple ways that their story could work out well — there are many options, and those options do not require investment on their part. It might not work, but there is more than one way that it could work — which is why the companies are worth something despite the fact that (arguably) their most valuable assets are royalty streams on iron ore mines, a mine that is shut down in MFC’s case, and a mine that may now not get built soon in Altius’ case.
When I look at my investing mistakes, I want to learn from them. Expecting a $20 valuation for Altius by the end of this year depended on there being some value in Altius’ Alderon holdings and, more importantly, in their large royalty on the gross production at Alderon’s Kami mine when it begins production (was expected to be 2015 sometime under the original timetable, now likely late 2016 at at the very earliest since Alderon has still not gotten their $1 billion+ required mine financing, and may not get that financing for a while unless iron ore prices stabilize or recover).
But because Brian Dalton and the team at Altius have other projects, there are other ways for them to make money. The biggest of those is their acquisition of royalties last year on electricity generation from coal and on potash — and they have substantial equity investments in two gold royalty companies (Callinan and Virginia Mines). So now, there are four different ways they can get cash flow or increase their assets: Gold can go up, making Virginia Mines and Callinan more valuable; soft commodities can rise, increasing demand for fertilizer and driving potash prices up (potash is at five-year lows); iron ore can rise, spurring development of the Kami mine and starting up that royalty stream; or electricity demand in Western Canada can rise or remain strong, keeping production going at their thermal coal plants (they get a per-tonne set royalty on coal, which is produced and then burned at power plants at the mine mouth in several places in W. Canada). The stock is not cheap right now, with potash and iron ore at low prices and gold pretty stagnant… but those commodities are not all driven by the same levers (well, unless you consider “general global economic growth” a lever), so even though Altius has traded down substantially in part because of iron ore weakness, it won’t collapse just because of iron ore weakness. Cliffs, as we’re seeing today, will collapse just on iron ore weakness…. and if iron ore does recover, there’s every chance that Altius’ Alderon holdings and Kami royalty stream could easily be worth $200 million in a few years. Put another way, both Altius and Cliffs have high potential if iron ore prices recover strongly over the next couple years, but as iron ore prices have fallen by 50% over the last three years Cliffs has dropped 90% and Altius has risen 10%. It’s really important to have more than one way to win.
I’m not trying to convince you to buy Altius, I’ve owned it and written about it many times and I know you’re perfectly capable of making your own decisions — but that optionality is what appeals to me most: the ability to win more than one way if you’re patient and willing to sit through some downturns.
MFC Industrial has the same thing working for them, though they are taking a good, hard beating recently too — partly because one of their most valuable assets is the Wabush iron ore royalty, a royalty on the mine, near Alderon/Altiius’ Kami project, that Cliffs closed down last year. MFC Industrial has a decent ongoing cash flow from its commodities distribution and merchant banking businesses, and optionality from the possible resolution of that Wabush royalty (and the minimum royalty that Cliffs owes even if they don’t operate the mine) as well as their natural gas processing plant and their undeveloped and partially partnered natural gas projects. So their levers are capital allocation by good and contrarian management, iron ore and natural gas prices, and general economic growth/commodities demand from industry. Again, may not work out — but it’s not just about iron ore and Chinese demand or just about natural gas, there are several ways it can work out well and profitably and, importantly, MFC Industrial, like Altius, doesn’t have to invest a lot of capital to make them work out.
Now that’s all well and good, but how about if you were trying to diversify with something cool and hip and new, like graphene? Lots of investors have been compelled to chase the graphene story when it has been so expertly marketed by lots of pundits in the newsletter industry, including several big pushes by various publishers for graphite miners and explorers. Graphene is not really an investment story, not yet, but that doesn’t stop speculators from turning graphite into an investment pitch and urging you to get aboard this “miracle material.”
And it is indeed a miraculous material, graphene (which is just a sheet of graphite/carbon the thickness of a single atom) may indeed change the world, replace silicon, and make all kinds of amazing stuff possible. And one way to make graphene, maybe the best way (no one really knows yet, we’re still a long way from commercially viable large-scale production of graphene) is by using high-quality large-flake graphite as your raw material.
And to make it even more exciting, what is the other hot up-and-coming technology story? Electric cars! And much better lithium-ion batteries, like the ones Tesla (TSLA) will be making in its new hyped “Gigafactory” in Nevada to bring down costs and make Teslas available to Middle America. And what to lithium ion batteries need beyond lithium? Lots of graphite!
So Graphite is a win-win, right? It might be used for graphene, and it’s already being used for batteries. So those who work with it or produce it should be about to swim in money, right?
Well, except for one thing: Those are the possibly growing applications for graphite, and batteries are indeed a pretty substantial end market already, but the biggest end market for graphite is… steel making, demand from which makes up close to half the graphite market.
So to a pretty substantial degree, graphite has the same driver as iron ore: Chinese steel demand. And iron ore is falling because… China doesn’t need as much steel as we thought, and there’s too much iron ore supply because Australian and Brazilian miners overbuilt and overexplored to meet anticipated demand five and ten years ago (it takes a long time to plan and build big mines).
There’s not necessarily an oversupply of graphite, and prices may well recover — I don’t mean to imply that I’m an expert on this — but try to think through the levers that move your various investments. For graphite, it’s steel production and increased lithium ion battery consumption. Lithium ion battery consumption at much higher volume depends at least in part on demand from electric cars, which obviously require much larger batteries than laptop computers. So if Tesla succeeds in moving from 30,000 cars to 300,000 cars, that’s a big push for graphite demand. If you want to think it through even further, you can also call this another bet on oil — if oil prices fall to $60 and stay there for a while, there might be precious little demand for a mass-market Tesla (there’s already precious little demand for the Nissan Leaf and Chevy Volt, though a $35,000 Tesla would no doubt be sexier, but it’s almost impossible to predict that market because it’s such a niche — it wouldn’t take much demand to double production).
I bring up all this graphite stuff mostly because I’ve been getting a lot of questions about Graftech (GTI) lately. If you don’t remember Graftech, it was a heavily teased stock pick from the Oxford Club as the company that would win the “race for graphene domination” about two years ago, and then re-teased using a lot of the same information last Summer, again emphasizing Graftech’s graphene patents and the potential of whiz-bang stuff like the graphene “super capacitor.”
I mentioned both of the times I covered this stock that, with 80% of the demand for their products coming from industry, particularly steel but also other “boring and dirty” industries, the best chance for GTI seeing a big price spike would be from substantial increases in steel production. Consumer electronic products, like heat sinks in laptops, are also a key potential area for them but not big enough, or high margin enough (electronics producers are rapacious about keeping costs low), to be big drivers.
And, well, we know how that worked out — GTI is down about 50% from where it was first teased, with most of that decline happening in the two weeks since they slashed their guidance for this year’s EBITDA and operating cash flow by about 30%, thanks in part to cost-cutting initiatives that will hurt them for the balance of this year but help, they say, starting in 2015.
So now how do things look for Graftech? Is it any more appealing now that the stock has fallen below $5 and perhaps some of the short sellers have begun to cover their positions? (haven’t seen a short tally since mid-September, so I don’t know about that).
Well, we do know that it’s not just GTI suffering — their big German competitor in the graphite electrode market, SGL, is also suffering and selling stock to raise money while they cut costs (SGL is a BMW partner, they also sell carbon fiber to the automaker but graphite is a good chunk of their business), so it’s not that GTI is necessarily an incompetent company — it’s just a bad business right now because of low demand and low end market prices.
And the actions they’re taking are fairly big — they’re moving the corporate headquarters to a smaller space in the next six months, and cutting headcount in addition to reorganizing to focus on growth areas in engineered carbon and graphite, and the total cost savings they see, some of which they’ve already implemented, will (they say) get them $120 million in annual savings.
That’s a lot for a company of this size — their annual revenue has only been about $1.2 billion, and $120 million is pretty close to what they made in gross profit last year (gross profit is revenue minus cost of goods, so that’s before you take out operating expenses, selling expenses, R&D, interest and taxes). Operating expenses have been pretty steady at 12-13% of revenue in recent years, so I guess they needed something dramatic to shake that up (like big headcount cuts and the HQ move), but presumably a lot of the savings will have to come from improved gross margins, too — margins have gotten considerably worse over the last year, whether that’s because of higher input costs or lower selling prices or just mistakes or bad luck, I don’t know.
Here’s what the CEO, Joel Hawthorne, said in their press release:
“Even at these operating income levels, as a result of our prior initiatives, we have adequate liquidity and we enter 2015 with planned and scheduled actions to generate additional liquidity through our previously announced working capital initiatives. We will continue to focus on taking further aggressive cost reduction actions to position the Company to be profitable at this low point of the cycle and strategically positioned to capitalize on the eventual recovery in end market demand.”
So really, to me it looks like they’re in survival mode — they have $35 million or so in interest payments they have to make each year, and plenty of other fixed costs that they’re trying to slice and dice this year and next, but they couldn’t be clearer about the fact that business is lousy and they’re just hunkering down to wait until it improves.
Which means … what’s the rush? They’re really just now taking this cost-cutting seriously, and there’s little danger that their business is going to see surging demand next quarter — if that was at all likely, they wouldn’t be moving their headquarters and firing people. They have spent a lot on R&D over the years, and they’ve been working with graphite for longer than almost anyone else, so it’s entirely possible that Graftech will be a leader in profitable new industries in engineered graphite and possibly graphene products in a few years, but right now it’s an engineered graphite supplier that’s suffering because the end markets for engineered graphite products are either too price-sensitive for them to make a profit (electronics) or slowing in demand (steel). Cutting those costs will not help Graftech generate profits, it will just ensure that they don’t have a crisis over the next couple years — their bit debt maturity isn’t until 2020, so they should be reasonably OK if their cost cutting works and the demand doesn’t fall further still (which it could), but they are clearly not in a great position.
Their debt was just downgraded, to heap a bit of misery on top of a bad month for them, so I’m sure they’d like to avoid borrowing any more money — at this point, there are no good financing options for Graftech, not with their equity at such low prices and with debt already matching equity (about $550 million in debt, market cap is $600 million). Here’s what Moody’s said, which basically reiterates all the other downgrades they’re getting:
“Moody’s Investors Service downgraded all long-term ratings for GrafTech International Ltd. (“GrafTech”), including the Corporate Family Rating (“CFR”) to Ba2 from Ba1.The downgrade reflects continued softening in the graphite electrodes business, increased volatility in the non-electrodes business, and tightening liquidity. All long-term ratings remain on review for downgrade.”
So as far as I’m concerned, graphene and graphite can wait — I’ve already got plenty of exposure in my portfolio to China’s demand for steel. And if GTI does well on their restructuring, they’ll still be there for us to consider in six months or so when there may be more clarity about future demand. I admit that I was tempted by the big drop in the share price, since bargains always entice, but the underlying business is so lousy that there’s no hurry.
And indeed, the graphite miners are not showing us any sign of urgency either as far as I can tell — Flinders Resources (FDR.V, FLNXF) has finally now restarted their historically producing graphite mine in Sweden, and the anticipation of that helped drive prices up this year, with Curzio’s Phase 1 being among the letters to tout and tease it, so the stock drove higher and higher, up over a dollar a share… only to collapse over the last month as they announced their first production and their official opening. I guess, once you’ve got a mine opened, folks start to think about whether or not you can actually run it profitably (OK, that was a cheap shot — I have no idea what the economics are, but the whole company’s only valued at $25 million.
And Focus Graphite, often a favorite of graphite and graphene enthusiasts, is trying to get financing together for their Lac Knife mine, though environmental permitting is still to be done, and their push to raise money for this next stage included an equity offering. That’s not generally what you’re looking for, it’s preferable to have a bank or customer finance your development, but even with their offtake agreement with a Chinese customer (who didn’t pay anything up front, apparently, the terms were confidential) they could only raise $1.93 million on the first phase of their $6.5 million equity raising plan. That might be an inauspicious start for a project that will require at least $160 million in startup financing — and really, since they’ve been burning through about two million in cash per quarter and had probably less than two million in cash at the end of September, this particular equity raise might not be about project financing — they might be just trying to keep the lights on.
Finally, the other one that gets teased quite a bit these days, in the slipstream of the Gigafactory that’s supposed to create massive new demand for North American graphite, is Northern Graphite (NGC.V, NGPHF), which jumped 50% in July when Nick Hodge said it was the “only option” for Tesla if they wanted to buy enough graphite for their batteries. That sounded somewhat logical, I guess, for those of us (me definitely included) who don’t really know the dynamics of the China-controlled graphite market or the science of battery construction very well.
Northern Graphite’s production capacity, according to their expanded assessment of this summer, is about the same as Focus Graphite’s — they have less urgent need to raise money, it appears, but that’s just because they’re not really doing anything as far as I can tell. They say they have a bankable feasibility study and their major environmental permit, and have had for quite a while, but I haven’t seen anything to indicate that they’ve actually tried to get financing for the mine ($100-150 million would be the capital costs, according to their assessment). They’ve been cutting back on some expenses, I expect, because cash burn has slowed slightly, but as long as they don’t really do any work (ie, they keep spending $400,000 a quarter on management, overhead and consultants but don’t undertake any work on the site) they’ve got enough cash (about $2.5 million) to get well into next year. If you read between the lines, it seems like they’re just waiting around for graphite prices to recover or for Elon Musk to jump in and buy them out. No idea whether that’s worth $10 million or $40 million (the current market cap) or something much more, but as with all areas of mining it seems like there is absolutely no financing interest out there — so why jump in when no one appears eager to finance even a $100 million mining project for a supposedly strategic metal? Either the whole world of investing is unbelievably stupid, or graphite is not as hot a commodity as the newsletters would have us think — I wouldn’t completely discount the former, particularly during strange times like these, but it seems like the latter is more likely.
Wait, I said “finally” but I should also mention Mason Graphite (LLG.V, MGPHF), which is another Canadian junior, a bit younger than the others but more heavily touted by big shots and a little larger ($65 million market cap, though they also have $5 million in debt) — not only our own Myron Martin, who has mentioned it positively, but investing guru Jim Rogers himself has publicly called it the best graphite play a couple times over the last year and said they have enough to supply Tesla, too (and he says he has an economic interest, don’t think he mentioned whether it was debt or equity). Mason hasn’t filed their second quarter with SEDAR as far as I can tell, I don’t know why, but they ought to be pretty much out of cash by now (they had a little over $1 million on March 31, they spent $600,000 in the first quarter). If you force me to do something in that sector I’d rather look at Imerys (NK in Paris, there isn’t really any pink sheets trading in this one), the industrial supply company Mason’s leadership came from that’s also a graphite supplier, since they have other businesses and pay a growing dividend (the operations have been pretty flat for a decade, actually, so the stock is probably too expensive — but it’s profitable).
So again, a big potential graphite deposit that no one appears particularly desperate to fund or develop… that’s true of lots of mining projects right now, of course, but the fact that the Gigafactory has essentially broken ground already and all the junior resources companies are sitting around waiting for someone to give them money is an odd juxtaposition.
Are all the natural resources pundits (and junior companies) wrong about how much graphite demand there will be from more battery production? Is the timing just too hard for this stuff, are there too many moving parts? (after all, every single natural resources analyst has been absolutely sure that uranium would rise this year, too, and it hasn’t.) Will lack of demand from steel refractories be enough to make up for new battery demand without lots of new mines? Beats me, but the economics, as described by the junior miners and the newsletters who tease them, don’t make sense to me. I’ll stay out of that mess until they do make sense — some of us are not meant to be the speculators who see their shares triple when Elon Musk helicopters into Canada with a briefcase full of cash, and that’s OK. Often, the helicopter doesn’t show.
Source URL: https://www.stockgumshoe.com/2014/10/friday-file-hodgepodge-iron-graphene-xerox-and-some-ranting/
Copyright ©2020 Stock Gumshoe unless otherwise noted.