Should You Buy It? Charting GrafTech's Potential

Updated from 6:50 a.m. EST

GrafTech International(GTI Quote) is not receiving much credit from investors these days, even though the company appears to be firing on all cylinders.

The stock is down more than 13% year to date, closing Wednesday at $15.44, even though it announced blowout fourth-quarter results on Feb. 28. GrafTech earned 38 cents a share, which was a full 7 cents ahead of the consensus analyst estimate. Revenue grew 14% year over year to $269 million, coming in $13 million higher than expected.

With that in mind, I'm here to answer readers' questions: Should you buy it? Can GrafTech trade back up to its October highs of $20, or is its low valuation too good to be true. (My prime role here at TheStreet.com is to analyze value stocks, which I do regularly for TheStreet.com Value Investor service.)

The company is the country's largest maker of graphite electrodes, which are used to produce steel and aluminum. GrafTech also makes products for transportation and semiconductor uses, giving it a wide range of customers, ranging from Alcoa(AA Quote) and Nucor (NUE Quote) to Cisco Systems(CSCO Quote) and Apple(AAPL Quote).

At current levels, GrafTech is valued at just 8.9 times expected 2008 earnings of $1.74 a share, compared with the average 13.7 times P/E ratio of the S&P 500. This also represents a steep discount to the 30% earnings growth the company is expected to post this year, following 135% growth in 2007.

That's the message sent by Oppenheimer analyst Robert LaGaipa, who downgraded the stock Feb. 29, following the quarterly report. Despite a favorable fundamental outlook, the analyst said that GrafTech lacks the near-term catalysts to send the stock higher.

That said, after the fourth-quarter results, management guided for 12% to 14% revenue growth in 2008, to $1.13 billion to $1.15 billion. This was ahead of the previous consensus analyst estimate of $1.11 billion, as the company said that demand looks strong across the globe.

GrafTech generates about 70% of its revenue overseas, making it a large beneficiary of the weak U.S. dollar. The company has also enjoyed strong pricing power in recent quarters, passing along higher input costs to customers. Looking ahead to 2008, management has already booked about 90% of its expected orders for the year and locked in 70% of its raw materials costs for graphite electrode production.

Another positive benefit of the company's earnings growth is that it's used internally generated cash flow to reduce net debt by 27% in 2007, to $370 million. GrafTech now has its lowest level of debt on the balance sheet in its 13 years as a publicly traded company, and I expect that management will further cut down on its borrowing in 2008.

So yes, I do believe that GrafTech is attractive to purchase at current levels. The company has exceeded analyst profit estimates each of the past four quarters, which is a trend that should continue in 2008, given management's strong earnings visibility. As a result, the stock can trade back up toward $20 over the coming quarters.

---

Know What You Own: GrafTech operates in the industrial electrical equipment sector, and some of the other stocks in its sector include Zoltek (ZOLT Quote); ABB (ABB Quote) and Eaton (ETN Quote). These stocks were recently trading at $23.78, $25.69 and $81.07 respectively. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

GrafTech is not included in TheStreet.com Value Investor model portfolio. David Peltier writes regularly about value stocks such as Smithfield Foods(SFD Quote), Chevron(CVX Quote) and Time Warner(TWX Quote).