What happens when you build too much manufacturing capacity but not enough customers to keep your factory floor busy? You lose money. The overhead costs quickly eat up any gross profits you make.

 

That has been the long-standing problem for carbon fiber maker Zoltek (Nasdaq; ZOLT). The company assumed that carbon fiber demand would surge, but in hindsight the company jumped the gun by opening up a new factory too soon. Sales fell from $185 million in 2008 to $128 million in 2010 as the economy slowed, turning a $20 million operating profit in 2008 into an $11 million operating loss in 2010. Business improved in 2011, though sales of $152 million were still far short of what management originally envisioned.

 

#-ad_banner-#You’ll recognize Zoltek from a few months ago. I originally recommended the stock to my $100,000 Real-Money Portfolio readers in early January. I encourage you to read that piece to see why I think this stock has such huge upside.

 

Yet as my mentor Bob Bogda later explained in this article (at the end of the piece), I never got a chance to add this stock to my portfolio at a rock-bottom price.

 

Shares eventually zoomed into the low teens on a solid quarterly report, which I covered here.

 

Well, despite that good news, shares drifted back, perhaps because analysts at Needham & Co. remained dubious of any upturn for this company, and placed a $10 price target and a “sell” rating on the stock. The stock almost got pulled down to that mark this past week, until Zoltek made a significant announcement.

 

The company is partnering with Magna (NYSE: MGA), one of the largest auto parts suppliers in the world. The firms will jointly develop carbon fiber products for automakers that are searching to shed pounds and boost the strength of their car and truck bodies. 

 

Why is this deal so important? Because Zoltek’s rivals, such as Hexcel (NYSE: HXL) and privately-held SGL Group (formerly known as SGL Carbon), are already deeply entrenched with forward-thinking auto makers such as BMW.

 

Zoltek already has a solid presence in aerospace and wind turbines, though exposure to the auto industry could really take this business model to the next level. Zoltek has ample idle manufacturing capacity, and any new business is likely to be nicely profitable, as fixed overhead costs are already in place.

 

So what was Needham’s take? They boosted their rating to “hold,” but remain wary. They correctly note that the partnership won’t bring in sales right away, but add that “this should eventually become a sizable opportunity for the company.” So their rating relates to short-term business trends, and not the long-term business opportunity.

 

I remain a huge fan of this company and am keeping an eye on the price action for an entry point for my $100,000 Portfolio.

  

Risks to Consider: Zoltek still delivers erratic quarterly results. Could the recent pullback tell us the current quarter won’t be as strong as the fourth quarter? Perhaps.