ArcelorMittal: Time To Go Long
Oct. 27, 2015
MT’s gross margin has declined at a far faster pace than the revenue this year, but investors can expect an improvement in the margin profile going forward.
MT will benefit from an updated infrastructure with better furnaces, while a government regulated steel production cut in China that could shrink output by 20% will lead to pricing stability.
MT’s steel commands almost 17% of the global auto market, which is good news since it will benefit from auto growth in key markets such as China, India, and Mexico.
An increase in modular platforms used by automakers to launch vehicles on a global basis will be a tailwind for MT as its addressable market will improve.
ArcelorMittal (NYSE:MT) has had a forgettable year so far with the stock down close to 50% as the company has struggled due to the influx of cheap steel imports from countries such as China into its end markets and the oversupply in the steel industry. In fact, over the past year, the decline in the company's gross margin has been alarming, even though it has controlled its revenue decline to some extent on the back of higher shipments. This is visible in the chart given below:
Why the margin performance will improve
However, the good thing is that the company is taking concrete steps to reduce its cost base in a bid to overcome the weakness in steel pricing. For instance, ArcelorMittal has been able to reduce its iron ore cash costs by 14% year-over-year in the last reported quarter, which resulted in a slight sequential improvement in EBITDA. Looking ahead, ArcelorMittal believes that it will be able to reduce its iron ore cash costs by 15% as compared to 2014. This will help the company mitigate the impact of weak steel pricing going forward.
Source: ArcelorMittal
ArcelorMittal has been able to achieve such impressive cost reduction numbers on the back of an improvement in its infrastructure. For instance, the company has invested in the construction of a heavy gauge line at its automotive plant in Canada. Apart from improving its galvanized steel capacity, this move has allowed ArcelorMittal to also reduce cost on the back of mix improvements.
Moreover, the company is also upgrading its Krakow blast furnace by modernizing the oxygen facility and relining the furnace. This move will help ArcelorMittal increase its hot-rolled and galvanizing capacity to the tune of 900,000 tons and 400,000 tons per year, respectively. Thus, by modernizing its facilities, ArcelorMittal is trying to achieve sustainable cost reductions that will lead to long-term gains.
Apart from cost reductions, ArcelorMittal's margins will also benefit from the expected stability in the steel market as key producing nations such as China are reducing steel output. According to China's National Development and Reform Commission (NDRC), the country's steel production has declined 2.1% in the first three quarters of 2015 as compared to last year. This is the result of conscious efforts undertaken by Chinese regulators in order to curb oversupply.
Looking ahead, China's steel production could decline further as "the government has banned new projects in steel, cement, electrolytic aluminum, flat glass and shipbuilding before 2017." In fact, Baosteel, one of the biggest steel producers of China, believes that the country's steel output could decline as much as 20%.
Now, this will have a notable impact on the oversupply in the steel industry since China is the world's largest steel producer. Thus, ArcelorMittal can expect some stability in steel prices, which will help it improve its margin profile when combined with its cost-reduction moves.
Tapping key automotive growth markets
While ArcelorMittal is focusing on reducing costs, it is not losing sight of the growth hotspots in the steel industry. For example, on the back of its advanced high-strength, galvanized, and coated steel products, the company is targeting automotive growth across the globe.
In fact, almost 17% of the global car production is from ArcelorMittal's steel, which indicates that the company is on track to benefit from improving auto demand across the globe, especially India and China.
Looking ahead, the company expects its automotive business to grow significantly this year as it is seeing growth in automotive in the emerging countries like China and India. As shown in the chart given below, China's auto sales are expected to increase 42% from 2014 levels to 2022. At the same time, automotive growth in India and Mexico is also expected to be strong.
Source: ArcelorMittal
This is good news for the company because 45% of vehicles manufactured in China use high-strength steels, while the adoption rate on a global basis is stronger at 70%. Moreover, ArcelorMittal will also benefit from an increase in the percentage of vehicles being built on global modular platforms in order to lower costs and churn out more products. In fact, the company sees the percentage of vehicles built on global platforms to grow from 46% in 2014 to 63% in 2020, which means that it will see an increase in the addressable market as its customers introduce the same model into different markets.
Conclusion
Though ArcelorMittal shares have lost a lot of value in the past few months and trade within a whisker of their 52-week lows, investors should not rule out a turnaround. The company is taking the right steps to counter the weakness in the steel market by aggressively reducing costs, while it is also focusing on growth markets such as automotive by upgrading the infrastructure.
Moreover, investors can expect some stability in the steel market due to production cuts in China, which will be another tailwind for the company. Thus, it might be a good idea to go long ArcelorMittal at current levels since it is capable of staging a comeback.