SGL Carbon – thoughts following guidance downgrade and impairment
All,
Please find our unchanged analysis of SGL here.
The impairments and guidance downgrade do not come as a surprise, given the significant impact of the covid crisis on two of SGL’s key end markets – auto and aerospace. SGL also had in the past a long and consistent track record of disappointing investors’ expectations, which triggered the most recent management reshuffle.
Terminating a large number of unprofitable low-volume products, and the ongoing site by site review of the business is a good start. However, it is still unclear if the SGL business on its own can be truly cash flow generative, even after stripping the weaker parts. As it stands, it is still far too early to see any results from these actions. This will probably have to wait for early 2021, considering management’s timetable for the corrective actions.
SGL is still planning to pay for its USD62m Moses Lake liability in Q4 20. While the company discuss other liquidity options, including mortgages and other secured debt, we see this s a meaningful and unnecessary drain on the company’s liquidity runway, and we are disappointed that it is not being postponed. With this outflow, liquidity starts to run low in late 2021.
SGL Carbon sees the Moses Lake facility as strategic for its business, as it makes carbon fibers mainly to the autos and wind segments, which are expected to grow, and not to the aerospace business. Further details about potential tax and payments deferrals during the coronavirus period were not provided by management during the call.
Management sees the business as lacking accountability for processes and outcomes, being run as an academic research institute instead of a for-profit organization, and having excessively loose capex budgeting processes. We tend to agree with their assessment. During the call, the new CFO has flaunted their turnaround credentials in businesses like Schaltbau. We will soon see if he can replicate that performance in SGL Carbon.
The results have been under pressure in 1H 20 as revenues were severely impacted by the Q2 20 shutdowns. While autos, aerospace and wind energy were the main topics of discussion during the call, the textile fiber business was singled out as one with a meaningful number of issues, including being subscale in many product lines, and not having an adequate path to profitability for a significant portion of the business.
We continue to project a FCF that will remain insufficient to cover SGL’s interest bills into 2021, in the absence of concrete and observable progress on the new turnaround plan. In this context, the convertible bonds would have a more appropriate fundamental value in the 40-50s, reflecting the significant risk of impairment in the case of another failed turnaround effort, as well as their subordinated position in the capital structure. However, the risks for a short position are also significant, as SGL Carbon has benefitted from continued financial support from deep-pocketed shareholders for many years, and it is not yet clear if this dynamic has changed. In addition, with SGL unlikely to face a significant liquidity crunch before late 2021, and the new management still enjoying strong support from the key shareholders, we do not see any immediate triggers for going concern risks.
Feel free to reach out if you would like to exchange ideas on the name.
Juliano
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