Description

GrafTech 6.375% Senior Notes: GrafTech (GTI) manufactures graphite electrodes, an input used by mini-mills in the EAF (recycled) steel manufacturing process. Formerly part of Union Carbide, the company is the largest and only vertically integrated global producer of graphite electrodes. In August 2015, Brookfield Asset Management (BAM), a publicly traded asset manager with $250b in assets under management, acquired GTI for $850m. The GTI notes sold off shortly after the deal on heightened concerns about global steel demand and market share gains by Chinese blast furnace producers at EAF producers’ expense. We like the notes – trading in the low-80s and yielding ~13% to their 2020 maturity – for two reasons.

First – the GTI notes are relatively attractive on a standalone basis. Restructuring plans implemented by the company’s new management team will leave it well positioned should industry conditions deteriorate further. Continued working capital improvements and the probable sale of a non-core segment will further reduce its modest leverage and improve liquidity. Continued capacity reductions and corporate rationalization will minimize the probability GTI burns substantial cash flow at the bottom of the cycle.  Its existing asset base, scale, backward integration and geographic proximity to customers (a critical requirement for suppliers to an industry where the cost of downtime is high) give us confidence in the long term viability of the assets.

Second – GTI’s evolving relationship with BAM is an unappreciated credit positive. During the 2^nd quarter 2016, BAM made GTI a key component in a new, publically traded, equity partnership Brookfield Business Partners (BBU). BAM employs such vehicles (it owns significant stakes in 3 others) as platforms to acquire related businesses through equity issuance and cash on hand. These platform companies are integral to BAM’s overarching strategy. GTI’s inclusion in BBU has twp potential consequences – all credit positive: 1) BBU is likely to consider issuing lower cost, entity level debt, to refinance the GTI notes; and 2) GTI likely has access to BBU’s substantial cash resources in the event of an extreme downturn – abandoning GTI after its inclusion would impair BBU’s ability to issue equity on favorable terms, an “asset” worth far more to BAM than could ever be lost in GTI credit support.

At current levels, the market seems focused on the macro and concerned GTI’s results will weaken further. We see upside in multiple scenarios and believe our downside protection is considerably greater than the market appreciates. 

Catalyst

BBU calls bonds