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
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 EBITDA 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
Disclosure: David Sterman does not own shares of any security
mentioned in this article.