Graham Corporation: A Hidden Gem in AI-Driven Industrial Markets?

The industrial sector is undergoing a seismic shift as artificial intelligence (AI) reshapes supply chains, manufacturing processes, and infrastructure. While the spotlight often falls on direct AI players, Graham Corporation (GHM) offers a compelling investment thesis as an overlooked beneficiary of this transformation. Its Q1 2025 earnings reveal a company positioned to capitalize on secular trends in defense and advanced industrial markets—sectors critical to AI's infrastructure—while trading at a valuation that lags its growth prospects.

Q1 Earnings: A Strong Foundation for Growth

Graham's Q1 results underscore its resilience and strategic positioning. Net sales rose 5% to $50.0 million, driven by a 28% surge in defense revenue, which now accounts for 51% of orders. Gross margin expanded 170 basis points to 24.8%, fueled by higher-margin defense contracts and operational efficiency gains. The backlog swelled to $396.8 million, up 23% year-over-year, with 35-45% expected to convert to sales within 12 months. This robust backlog—equivalent to 1.9x annualized sales—provides clear visibility into future revenue streams.

Defense: The AI-Infrastructure Sweet Spot

While Graham isn't a direct semiconductor player, its role in AI-enabling infrastructure is understated. Defense programs, such as the U.S. Navy's MK48 Mod 7 Torpedo and advanced surface condenser systems for net-zero carbon projects, are critical to next-gen military and industrial systems. These systems often rely on precision fluid handling and heat management—the core of Graham's expertise.

The Pentagon's push for AI-driven defense modernization, including autonomous systems and advanced propulsion, is accelerating demand for Graham's components. The company's $2.1 million grant for defense welder training and its new 29,000 sq. ft. Batavia facility signal strategic bets to capitalize on this trend. In contrast, peers like Boeing (BA) or Lockheed Martin (LMT) face valuation premiums that reflect broader defense sector risks, while Graham's narrow focus on niche, high-margin segments offers a better risk-reward profile.

Semiconductor Exposure: Indirect but Strategic

Though the Q1 report doesn't explicitly mention semiconductors, Graham's work on net-zero carbon ethylene cracker projects aligns with the rising demand for advanced manufacturing infrastructure in semiconductor production. Ethylene crackers are integral to producing materials for semiconductor chips and clean energy systems. Graham's backlog includes projects like a “net-zero carbon emissions ethylene cracker site,” which directly supports the green industrial infrastructure needed for AI's energy demands.

Valuation: A Discounted Growth Story

At $42 per share, Graham trades at a 10.3x forward EV/EBITDA, significantly below peers in industrial and defense sectors (e.g., Rockwell Automation (ROK) at 18x or Northrop Grumman (NOC) at 16x). This discount ignores its strong balance sheet ($21.6 million cash, no debt) and secular growth catalysts:

1. Backlog Conversion: The $396.8 million backlog, with 35-45% to convert in 12 months, positions FY2025 sales at $200–210 million—a 10–15% increase over FY2024.
2. Margin Expansion: Gross margins are on track to hit 22–23%, up from 2024's 20.2%, as higher-margin defense work scales.
3. Strategic Investments: The Batavia facility and BlueForge grant enhance capacity and talent to lock in long-term defense contracts.

Assuming 15% earnings growth and a modest 14x EV/EBITDA multiple (in line with industrial peers), Graham's stock could reach $52.67, implying 25% upside.

Risks to Consider

• Defense Budget Volatility: U.S. defense spending could face political headwinds.
• Execution Risks: Scaling new facilities and training programs may strain resources.
• Commodity Costs: Input price pressures could squeeze margins if not offset by pricing power.

Investment Conclusion: Buy with Confidence

Graham Corporation is a valuation anomaly in an AI-driven world. Its niche in high-margin defense and industrial infrastructure—critical to both military modernization and semiconductor-era manufacturing—positions it for sustained growth. With a backlog-driven revenue runway and a balance sheet untainted by debt, Graham offers a compelling buy at $42, targeting $52.67. Investors chasing AI's industrial revolution would be wise to look beyond silicon chips and consider the unsung enablers like Graham.