A Former High-Flyer Staging a Long-Term Comeback

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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 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
Contributor
StreetAuthority

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



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Stocks

Referenced Stocks: ZOLT

David Sterman

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