SGL Carbon – It is getting windier, time for a rest on the shelf.
All,
Please find our unchanged analysis here.
In the first 9-months of 2021 SGL Carbon has experienced sustained top line growth accompanied by improving EBITDA. The pace of growth is slowing, and rising costs are stymieing margin growth; however, we expect that at the FY stronger profitability along with sales of excess assets will see free cash flow of over €120m in 2021. The 3.0% 2025 Convertible bond is likely to be redeemed in 2022 as Management will look at refinancing options once the FY21 results have been published. We are long both the SSNs and the convertible, which now both trade above par. Given limited upside and potential cost issues in 2022 we will be exiting our position and will be shelving coverage of SGL carbon.
Strong cash flow, but headwinds are growing:
- Operationally the 9-month period has been strong, however the third quarter showed some strain when one-off impacts are stripped out. Revenue was up 14% in Q3 at €271m but gross margin fell from 23% to 22% sequentially. Some of this will be lower volumes due to lower sequential revenue, but we expect some push back from customers on price increases resulting from higher energy )in Europe) and rising raw material costs. The blip is small so far, but suggests some tough negotiations on longer term contracts in 2022. We also do not expect any relief on energy costs in the European business until H222. Operating expenses were impacted by the high cost of transport (shipping costs and rising labour costs) and we expect this pressure to persist through H122. As a result, EBITDA was flat sequentially at €32m with margins of 13.8%, lower than the 14.4% achieved in Q3 20 (and the 15.2% in the previous quarter). The semiconductor shortage has not impacted demand at high end automotive businesses so far, but management acknowledge the potential for issues in 2022.
Lower EBITDA margins flowed through to lower operating cash flow (€13m), we don’t expect relief in Q4 as margin pressure is going to continue. We are not very concerned about this in the short term. The energy costs will impact all European based manufacturers and the cost and availability of shipping capacity will reduce competition from imported supplies. Also, with €237m of cash available SGL is in a strong position to weather H1 22 cost issues.
- Graphite Solutions (45% turnover) strong top line performance due to demand from the semi-conductor industry (up 30% year on year). Automotive demand was also strong, however SGL acknowledged that it was starting to see some cancellations (due to chip shortage shutdowns). This is likely to see auto sales fall in H122 and be replaced with lower margin renewables sales.
- Carbon Fibre (32% turnover) Top line growth was only 2% up on Q320 but performance was better than the company expected. The high-end auto brake business performed strongly, and this compensated for the impact of energy costs in Europe and raw material costs generally. These costs led to lower production at the Lavradio plant in Portugal, where four of eight lines were closed as apparel customers switched to cheaper options.
- Process Technology and Composite Solutions are both benefitting from higher utilisation rates, and this is flowing to higher margins
3% Convertible Bonds:
- There is €159m of principal outstanding. The bonds have a strike of over €13 vs the current trading level of €9.37. SGL is likely to take these out first before seeking a refinance of the €250m SSN’s.
Positioning:
We are long both the SSNs for 4% of Nav at 92 and the convertible bonds for 2% at 82. Our original thesis was that the SSNs would pull to par as cash flow improved and this has happened. The convert is also trading above par and we expect it will be redeemed next year. Given the cost headwinds facing SGL, we will be seeking to exit the name and will be shelving the name
As always, we look forward to any views you all may have on this.
Regards
Aengus
E: amcmahon@sarria.co.uk
T: +44 203 744 7055