GrafTech International Ltd. (EAF) Q4 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the GrafTech Fourth Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to turn the call over to Wendy Watson, Vice President, Investor Relations. Please go ahead.

Good morning, and welcome to our fourth quarter and full-year 2020 conference call. On with me today is Dave Rintoul, GrafTech's Chief Executive Officer; and Quinn Coburn, our Chief Financial Officer. We are conducting the call from different locations today. So please bear with us if you experience minor delays or mixed audio quality. Turning to our first Slide. As a reminder, some of the matters discussed on this call may include forward-looking statements regarding among other things, results, 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. The results we discuss today are based on our unaudited results for the year ended December 31, 2020. 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 Dave.

Thank you, Wendy. Good morning, everyone, and thank you, for joining our fourth quarter and year-end 2020 call. I hope you, your families and your colleagues are healthy and well. We will begin as we always do with safety. Our 2020 full-year total recordable injury rate is 0.51, a 46% increase – decrease, excuse me – improvement from 2019. Continuing our improvement trend over the last three years, health and safety excellence is a core value of GrafTech and demonstrates our keen focus on continuous improvement across our organization. I am very proud of the diligence and hard work by our global team in the safety area, as well as their response to the challenges created by the pandemic over the past year. Our plants have been diligent and thorough in their COVID-19 controls and associated audits. Our team members continued to adhere to exacting protocols, and we continued to proactively manage our response to the pandemic. I want to personally thank the GrafTech team for your efforts in 2020. As we enter 2021, we must remain vigilant to reach our ultimate goal of every employee going home safely every day. Health and safety are fundamental to our belief that a safe plant is an efficient plant. As a global team, we are proud of our culture of continuous improvement and the strong safety metrics we reported in 2020. That spirit of continuous improvement comes into other areas, including our 97% on-time delivery performance in the fourth quarter [indiscernible] of our focus on efficiency and the highest level of customer service. Moving to Slide 4. As those of you who follow our company know health and safety is not the only place where we begin our conversation each quarter, but as a cornerstone of our focus on ESG efforts globally. Quinn and I, and our senior executives participated in our ESG Steering Committee. The steering committee oversees our sustainability strategy, which compromises or comprises rather of employee health and safety, community relations, material sourcing and efficiency, energy management, greenhouse gas emissions, air quality, water and wastewater management and waste management. The strategy encompasses activities as varied as our community involvement and [indiscernible] in Monterrey, Mexico. Our capture of energy generated our Seadrift Coke facility to create additional sources of electricity for the area and our emission reduction efforts that include the installation of control technology and equipment on all of our sites. Our goals are centered on improving our environmental footprint across our operations. We are working hard to be good corporate citizens in the communities where we operate and every day our business decisions and actions are guided by our code of conduct and ethics. We look forward to continuing our ESG dialogue with you and publishing our second annual sustainability report later this year. Now turning to Slide 5. Late in 2020, we began seeing measured recovery in global steel markets, including improvement in steel pricing and capacity utilization rates. Fourth quarter global steel production outside of China improved to 211 million tons from 191 million tons in the third quarter, according to the World Steel Association. Global steel manufacturing utilization rates outside of China improved in the fourth quarter to 72% from over just 60% in the third quarter. Steel industry fundamentals continued to improve with pricing for most types of steel at or near all time highs. USA hot-rolled coil values are currently at approximately $1,160 to $1,180 per ton and we are up over 75% in the fourth quarter. Black Sea billet prices were approximately $540 to $560 per metric ton, and we are up over 30% in the fourth quarter. We expect continued steel industry strength to positively impact the graphite electrode market later in 2021. As you know, our industry lags demand recovery in the steel industry due to our position in the steel producers supply chain. As the steel industries capacity utilization improves, we first see increasing demand for graphite electrodes, which is enfold by higher pricing for our products. Each of these movements in the graphite electrode supply chain is at a lag to the steel producers increasing demand. In the fourth quarter, our average price from LTA sales of graphite electrodes was approximately $9,600 per metric ton, and our average price from non-LTA sales was approximately $4,900 per metric ton. Turning to Slide 6. Our commercial team worked hard throughout 2020 to service our customers and to develop mutually beneficial solutions to challenges they faced during the year, including volume commitments. Going forward, we remain focused on providing superior services and solutions to our valued customers. The estimates we announced last November for expected graphite electrode sales volumes under our LTAs have not changed. In 2021, we estimate our LTA sales volumes will be in the range of 98,000 to 108,000 metric tons. 2022 will be in the range of 95,000 to 105,000 metric tons, and for the years 2023 through 2024, we estimate LTA sales volumes of 35,000 to 45,000 metric tons. I'll now turn the call over to Quinn on Slide 7 to discuss our fourth quarter and full-year 2020 financial results. Quinn?

Okay. Thanks, Dave. We are pleased with our fourth quarter 2020 financial results and the steady sequential improvement we are seeing across our key metrics. Fourth quarter 2020 net sales were $338 million, a sequential improvement of 18% from third quarter. In the fourth quarter, production and sales volumes of graphite electrodes improved sequentially to 36,000 metric tons of graphite electrodes produced and 37,000 metric tons of graphite electrodes shipped. Fourth quarter LTA shipments were 31,000 metric tons and full-year LTA shipments were 113,000 metric tons. Our non-LTA sales in the fourth quarter consisted of 6,000 metric tons of electrodes, bringing our full-year non-LTA sales to 22,000 metric tons. Now turning to Slide 8. Despite the challenges of 2020, we were able to deliver solid results for the year with $1.62 of full-year EPS, $659 million of adjusted EBITDA and $528 million of free cash flow. Sequential improvements continued in the fourth quarter of 2020 with net income of $125 million up 33% from the third quarter and earnings per diluted share of $0.47 up 34% over third quarter EPS. Fourth quarter adjusted EBITDA of $176 million and fourth quarter free cash flow of $142 million were both up 15% from the third quarter. As you will see on Slide 9, we used the majority of our 2020 free cash flow to repay debt. As I mentioned previously, GrafTech continued its strong track record of free cash flow generation in 2020 with $528 million of free cash flow. Our 2020 capital allocation included $400 million of debt repayment, $31 million of dividend payments and $30 million for share repurchases. Now moving to Slide 10. We significantly strengthened our capital structure in 2020 pursuant to our commitment to reduce debt and maintain balance sheet flexibility. Over the course of the year, we reduced our debt by $400 million. In December, we issued a $500 million, 4.625% senior secured notes due in 2028. We used the proceeds to repay a portion of our term loan. These transactions effectively extended the maturity of $500 million of our long-term debt by approximately four years, further enhancing our financial flexibility. At the end of 2020, our total liquidity was approximately $392 million, consisting of $145 million of cash and $246 million available under the revolving credit facility. Now on Slide 11. In 2020, we anticipate another year of significant cash flow generation. We expect to use the majority of that cash flow to further reduce debt. Our focus on the balance sheet and maintaining a strong capital structure, provides us with significant financial, operational and strategic flexibility. We also plan to invest in our business both through maintaining our high-quality, low cost global operating assets and targeting high return operational improvements. We look to deploy cash into projects designed to reduce operating costs, increased productivity and develop products that our customers value. We expect full-year 2021 capital expenditures in the range of $55 million to $65 million. Now I'll turn it back to Dave on Slide 12.

Thanks, Quinn. GrafTech is one of the largest producers of ultra-high-power graphite electrodes in the world, operating three of the largest global facilities. Graphite electrodes are mission-critical component to the EAF steel industry, and there is no substitute for our product. Our customers are the lowest cost producers of steel, and they are some of the largest recyclers in the world producing steel with 25% of the carbon emissions of traditional integrated steel producers. We have a sustainable and long-term competitive advantage from our low cost structure and vertical integration into our key raw material petroleum needle coke. Our graphite electrodes are highly engineered and require extensive process knowledge to manufacture. The services and solutions that GrafTech provides help positioned both our customers and us for a better future. Our balance sheet commitment and proven track record of high quality earnings and significant cash flow generation gives us the strength to manage through the industry cycles. With commitment of our people and our significant competitive advantages, we continue to strongly believe GrafTech is well positioned today and over the long-term. That concludes our prepared remarks and we will now open the call for questions.

[Operator Instructions] And your first question comes from Arun Viswanathan with RBC Capital Markets. Your line is open.

Great. Thanks for taking my question. Good morning, and congratulations on the performance in 2020. I guess, first question is, could you just provide an update maybe on spot pricing in electrodes and needle coke? Obviously there's been a nice improvement as you referenced in steel pricing and utilization rates. Have you started to see that flow through on the needle coke and electrode side?

Sure, Arun. Thanks for your question and your interest in the company. So as I referenced earlier, there is a lag, but we believe that as we've transferred through the – into the first quarter, once pricing is bottoming out and volumes have started to pick up. So we're – that's why we're optimistic about 2021. We think as those – influence of those prices filter through the year, remembering that today we are negotiating orders that are delivering in late Q2 and into Q3, we'll start to see the impact of improved pricing. On needle coke, I think we're starting to see that a similar trend and that was an expectation that as we go through the year and needle coke pricing will increase also.

Okay. And thanks for that. And I guess, a couple more so. I guess in the past, you'd referenced some months of inventory still in the industry on the electrode side. How would you size the inventory position now with your customers? I think in the past, you'd referenced something in the six-month range. Is that still where you see things now or has that kind of also shortened with the improvement in the steel utilization rates?

Sure. One of the reasons you have the lag is because people work down inventory as there – before they start placing new orders obviously, as they see shifts to be sure that the market is continuing in that trend. So we are seeing that that inventory has been worked down significantly and approaching as we – the stock at this time approaching what we would call a normal amount of inventory. And I think we said on the last call that we expected that would be completed by both the end of this quarter. I think that still is a hard trajectory. I think the inventory build that had taken place is has been worked down nicely.

Okay. Great. And then I guess just looking ahead then, you've laid out the LTA volumes that you expect for the next couple of years. What do you expect as far as maybe some of the merchant and spot volumes? How do those evolve through the year? Do you see a scenario where maybe in 2022 you'd get back to kind of your 2018 levels of spot volume sales? Or how does the spot book evolve for you guys?

So we are optimistic about the spot order book to be sure. I don't think today that we would be brave enough to be trying to predict what 2022 is going to bring. But we are certainly optimistic as we go through this current year and see a sizable increase in the amount of spot business that we do in 2021 compared to what we did in 2020. So I think we are cautiously optimistic about the future, of course, assuming the continued rebound that we are seeing in the steel industry remains going forward. And at this point in time, we don't see any reason to believe anything different.

Okay. And then just lastly for me, when you think about the uses of cash, I guess in 2021, deleveraging was obviously a focus in 2020, but maybe you're in a slightly better position to return capital to shareholders in 2021, I guess. Is that the case? And maybe Quinn, you can just layout kind of how you're seeing priorities for cash used at this point?

Quinn, I’ll leave that to you.

Yes. So as we noted in our comments, Arun, I mean, first and foremost, I think we will focus on making the appropriate investments in our business, maintain our high quality assets, continue to invest in high return projects, anything that would improve our operations and have a high return. And as I mentioned, we plan on a CapEx of $55 million to $65 million. So that would be the first priority. Second priority just from a philosophical standpoint is we do have an emphasis on a strong balance sheet as we have had for the last couple of years. I think it's appropriate and in our best interest and in the shareholders best interest to operate from a position of balance sheet strength. We think that gives us financial operational flexibility and is very appropriate for the industry that we are in. So in 2021, we will continue to focus on balance sheet strength. That will be our number one priority. Our number one priority forecast will be to continue on our – reducing our debt level. And as you note, we've returned cash to shareholders in the past, we continue with our dividend and we have $59 million remaining on our open market share repurchase program. So of course, that will continue to be an option. But as we mentioned, our first priority will be balance sheet strength and debt reduction.

Great. Thanks.

[Operator Instructions] Your next question comes from David Gagliano with BMO Capital Markets. Your line is open.

All right. Great. Thanks for taking my questions. I think Arun had hit a lot of them. But I just want to follow-up on the capital allocation policy, drill down a bit further on the philosophy there, the last comment. Obviously substantial progress in reducing debt levels and what was obviously a challenging year. And one could argue that the balance sheet will be under levered substantially, especially if we continue to direct the vast majority of the cash that's coming to debt reduction. So is there an optimal level of capital structure, for example, net debt-to-EBITDA even on a normalized basis or even on an outright basis, comfort level of net debt whereby you would actually start directing more of that cash to the shareholders as well as the debt reduction initiatives?

Yes. Sure. David thanks for that. So the way I would characterize it is, we do quite a bit of discussion at the management level, at the Board level on an ongoing basis, as you know, as we've discussed before. And with regards to the target debt level, we have – and fairly consistent, we have been very consistent in communicating and managing to a leverage level of no more than 2x to 2.5x, currently we're at 2.2x. And as I said, that target is our maximum range and we're comfortable operating below that level as well just as a note for most of 2018, 2019, we operated at a level of around 1.7x to 1.8x. So again, we're comfortable operating below that level. I think the key decisions with regards to exactly how much debt we hold will depend on what the future brings in terms of long-term contracts and also what the business conditions are like in the future. But as we've mentioned, our key priority will be to maintain that flexibility through the cycle. So we have the financial, operational and strategic flexibility that we believe is in the best interest for the company and the shareholders to operate with.

Okay. Understandable. I think though, if one did the basic math on kind of run rate cash generation and apply that to the out years if GrafTech shifted to a sort of a – even a 50-50 capital allocation, probably similar to the one in 2019. You would be effectively below 1.5x leverage on a normalized EBITDA of $500 million. So I think that's right. So I'm curious is that normalized EBITDA assumption too high or is there something else that we should be thinking about here?

Dave, I think it's just – I think you're spot on. I think, we could drop down below, again the 2x and be comfortable with that. And as I noted, we continue on an ongoing basis to discuss at the management and Board levels and we'll continue to assess and when the right time is to shift to return more cash to shareholders. Then we'll make that shift at the appropriate time, absolutely.

Okay. That's perfect. Thanks. And then just one last one for me. Short-term, can you just give us a little more color on your – given that we're five weeks into the first quarter on your volume expectations for the first quarter. That's it from me.

Thanks, David. I think as we came out of the fourth quarter, which was a good quarter for us. We saw some late LTA improvement as people were trying to clean up some obligations, which we were appreciative of. And as we move into the new year, we start the cycle. Again, I think we'll see an increase in some of the spot business and some – we have a few LTAs, that were three years at drop-off and I think we've given some guidance on that. So I think the – we see steady improvement, I think, quarter-over-quarter for the year. And are optimistic about where the quarter – excuse me, where the year will take us. Usually the first quarter is a bit of an adjustment as people are trying to sort out where they're going to be. So I think – I don't think Q1 will have a big – won't have an increase from where we left off in the fourth quarter, but we'll grow there, I think quarter-over-quarter in the second, third and fourth quarter.

That's great. Thank you very much.

Your next question comes from Alex Hacking with Citi. Your line is open.

Yes. Good morning, Dave and Quinn. Thanks for taking my question. Most of them were already asked. But I do have a couple. Firstly, you talked about the priority being reinvesting in the business, CapEx remains relatively low. And obviously you have excess capacity in your current operations in St. Marys. Are there capital projects that you could see yourself doing at some point in the future that would raise CapEx materially? I don't know, above $100 million or something like that, or is this kind of CapEx level, what really we would be looking at for the foreseeable future? Thanks.

Alex, I think this is a sustainable level of CapEx. With the best vision we have today in the market that we're servicing it – certainly, I can tell you, we don't have any visions of anything that would take us to a number that's over a $100 million as you suggest. But we do remain flexible in terms of, if there was an opportunity that came up. So that's the way we view it. In terms of the ongoing business, I think that's a sustainable value. But we would remain flexible to opportunities that might come along in the future that we're not aware as that time of this call. Quinn, anything to add?

No. That's absolutely right. I think, in 2018, 2019, we operated sort of at the, call it, $55 million to $65 million level of CapEx. And we view that as a good level of CapEx for us. As we demonstrated this year, we can reduce as needed, but this is a good level, allows us to, again, reinvest, continue to keep our assets in very good shape and continue to maintain our low cost position in the marketplace.

Thanks so much. And then the second question, I'm asking this question at least 12 months too early. But philosophically, do you see yourself wanting to sign long-term contracts again, as we approach the end of – in 2022, when the original five-year contracts are going to start rolling off. Do you see yourself wanting to get into the business of long-term contracts again? And do you see your customers wanting to do it, or is it just simply a matter of pricing effect? Like at some price, customers would do it, at some price, you would do it and have to see if those two price ranges overlap. Thanks.

Sure, Alex. Look, I think one of the things that we're particularly proud of, and I think that provides GrafTech a leg up because we do offer a variety of ways in which to do business with us and because of our vertical integration, we're the only one that's capable of providing the longer-term contracts in a sustainable way. So we expect to continue as we move forward to offer our customers the opportunity to do longer-term arrangements, and shorter-term, one-year, two-year type agreements in – what we call short-term and then even spot. So I think – and we've some interesting ideas that we've worked on with a few customers around some degree of indexing if you will. So these are all things that we think we bring to the table that are good for our customer base. In terms of the LTA specifically, we will continue to provide that availability. I think we'll have more insight into that as we get into 2022, of course. But I think that's an instrument that still has a valid place. And I've referenced this before that it's a little bit like hedging and people hedge their natural gas and electricity and those kinds of things all the time. So we'll certainly be offering that tool to our customers. And as you said, it's a matter of what price it'll be at that point in time in the markets. So I think these are tools that others can't offer that we can provide an advantage to our customers.

Okay. Thanks so much. And congrats on all your success last year, particularly on the safety side and generating cash and improving the balance sheet. Thanks.

Thanks, Alex.

Thanks, Alex.

And there are no further questions queued up at this time, I will turn the call back over to David Rintoul for closing remarks.

Thank you, Denise. I'd like to take this opportunity to wish everyone on this call health and safety in the coming months. Thank you for your interest in GrafTech. And we look forward to speaking with you at the next quarter. Take care and have a good day. Thank you.

This concludes today's conference call. You may now disconnect.