Published: February 24, 2010
When a hot new technology shoots out of the
gate, investors often get spoiled. They expect demand to keep
growing and growing, and have little patience when the industry
hits an inevitable speed bump. In recent years, carbon fiber
garnered considerable buzz, as the lightweight -- yet
super-strong -- material found its way into a raft of new
applications such as airplanes, cars and wind turbines. But as
the global economy cooled, so did demand for carbon fiber, due
to its relatively high cost. But analysts believe demand is only
stalled and a host of new products set to use carbon fiber
should boost sales anew.
For investors, this creates a nice entry point for Zoltek
Companies, Inc. (Nasdaq: ZOLT), one of the industry leaders.
Zoltek has seen sales slump in recent quarters, but all signs
point to a second-half rebound. Meanwhile, shares, which peaked
at around $50 in 2007, can now be had for under $10. That’s an
important price support level, because it’s not far above the
company’s book value of $8.93 per share.
To be sure, Murphy’s Law has certainly applied to Zoltek. The
company significantly invested in additional manufacturing
capacity right at the time demand slumped. You can understand
why management had chosen to build additional plants: sales
soared more than five-fold, to $185 million through fiscal 2008,
from $35 million in 2004. But it’s been a tale of woe since
then, and sales are likely to barely exceed $100 million in the
current fiscal year ending Sept. 30.
Part of the sales slump is a result of a decision by a key
customer to sharply reduce the amount of carbon fiber it holds
in inventory. Vestas, the world’s largest maker of wind
turbines, routinely represented a large portion of Zoltek’s
sales, but recently said it would hold off buying carbon fiber
until this summer. At that time, both companies expect the
relationship to build back up.
That customer dependence highlighted the key risk for investors.
You should generally avoid companies that are too vulnerable to
just one customer -- a lesson Zoltek investors learned the hard
way. In response, management has been working to woo additional
customers, and noted that three new clients have been using
carbon fiber in their prototypes.
In coming months, we may hear that one or several of those
prototyping customers place meaningful orders. When combined
with an eventual pick-up in demand from Vestas, this should help
sales rebound in the second half of calendar 2010.
For Zoltek, that can’t come soon enough, as the company is
saddled with an excess of manufacturing capacity, which is
weighing on gross margins. The company historically generated
gross margins in the 27% to 28% range. In the most recent
quarter, management noted that the carrying cost of that unused
capacity pushed gross margins down below 15%. As sales rise, and
the slack gets taken up, gross margins are likely to move back
up above 20%.
The current fiscal year could be somewhat disappointing,
especially if the expected second-half rebound won’t be enough
to offset the lackluster first half of the year. So we can look
ahead to fiscal 2011 and fiscal 2012 to get a sense of the
company’s potential profitability. Assuming a baseline of $100
million in sales this year, the rebound from Vestas and any new
customers should boost revenue back up to $125 million in Fiscal
2011, and gross margins back into the upper teens.
Using those figures, and assuming fixed costs stay constant,
then Zoltek should generate about $0.30 a share in
fiscal 2011. If sales rebound to $150 million in fiscal 2012 and
gross margins hit 22% (well below recent peaks), Zoltek would
earn around $0.70 a share in EBITDA. (As a point of reference,
Zoltek generated $1.21 in EBITDA in Fiscal 2008 before the
global economy cooled). It may be a while before Zoltek
re-visits those operating peaks, but shares, which trade right
at book value, are pricing in the current bad news and giving no
credit to an eventual rebound in profits and demand.
-- David Sterman