Steel supplier GrafTech (EAF 2.03%) has seen its shares crumble this year. But the company is one of the largest suppliers of a relatively unknown raw material that goes into lithium-ion batteries used in electric vehicles (EVs). Aside from the EV trend, there is another undeniable trend the company should benefit from. Here's what I mean.
Second derivative EV play
As customers continue to embrace the EV trend, manufacturers will need more and more lithium-ion batteries every year to install in each car. One way lithium-ion battery manufacturers can make their batteries more efficient is by using a little-known raw material called needle coke. Graphite produced from needle coke has properties that make it one of the best materials to conduct electricity at higher temperatures.
Needle coke gives lithium-ion batteries higher energy density and allows them to charge faster. These are two of the most prominent selling points of electric vehicles, making needle coke a critical raw material in enabling the advancement of EVs.
Image source: Getty Images.
The growth of EVs is quickly becoming tangible. Last quarter, Ford (F 0.66%) announced that its EV sales jumped 77% over last year's second quarter to 4,353. All-electric car maker Tesla (TSLA -1.92%) reported it delivered over 250,000 EVs during the quarter, a 27% increase over last year. Peering down the road, Ford plans to sell two million EVs by 2026, and Tesla expects to grow its deliveries by 50% annually.
The list of car manufacturers with ambitious EV goals is long. According to GrafTech's annual report, demand for needle coke for EVs could increase more than sixfold, from 100,000 metric tonnes in 2020 to over 650,000 metric tonnes by 2025.
Here's where GrafTech comes in. The company's subsidiary, Seadrift, is one of the largest producers of needle coke in the world. Though GrafTech does not sell its needle coke to EV manufacturers (more on that later), growth in EVs and lithium-ion batteries could apply very significant upward pressure on the price of needle coke-based products that GrafTech sells.
On the supply side, needle coke capacity has been flat for several years. Building new capacity requires massive capital investment and can take years to complete. Furthermore, the regulatory process to build new capacity is cumbersome. So, the outlook for the supply of needle coke remains stable. Because GrafTech has its own low-cost raw material supply, higher prices could lead to an awe-inspiring expansion of its profit margin.
A must-have steelmaking component
Though blast furnaces still make up most of the steel-making capacity, they're being replaced by electric arc furnaces that use electricity to melt steel. Electric arc furnaces require significantly less money to build and lower ongoing expenses. The market for these furnaces is expected to grow by 11.1% through 2025.
GrafTech sells electrodes that electric arc steel makers use. The electrodes conduct electricity in the steel melting process. Each electrode lasts for eight to 10 hours and must be replaced continuously. Though replacement electrodes depend on steel production, replacement electrodes create a source of repeatable sales for GrafTech. The primary raw material in electrodes is, of course, needle coke. Being one of the only vertically integrated electrode makers, GrafTech is a low-price leader in the electrode market.
Should you buy the dip on GrafTech right now?
Though the EV market is expected to see incredible growth over the next several years, it is still nascent. As the EV market develops over the next decade, demand for needle coke should drive prices up and provide meaning margin expansion and profitability for Graftech.
Being a steel supplier, a global economic slowdown could hamper the company in the short term. This concern may already be reflected in the stock, which is down 40% this year. With long-term growth catalysts, the stock has an enormous long-term upside. Investors will need patience and a stomach for volatility, but this could be an excellent opportunity to buy the dip on GrafTech.
