ArcelorMittal's Low Valuation Offset By A Weak Price Outlook
May 13, 2020 11:10 AM ET | About: ArcelorMittal (MT)
Stephen Simpson, CFA
Long only, growth at reasonable price, value, research analyst
Kratisto Investing
(11,985 followers)
Summary
ArcelorMittal is looking to shift its cost structure toward variable costs and has curtailed some capacity across its major operating regions, but Q2'20 should be the bottom for industry shipments.
The key complicating factor is the future trajectory of steel prices. Construction demand is likely to be weaker for a few years and steel prices could drift lower in response.
ArcelorMittal has announced its intention to raise $2 billion in capital; a highly dilutive move that seems unnecessary.
ArcelorMittal shares look meaningfully undervalued, and inferior operations tend to outperform when steel prices strengthen, but there's no clarity now on a sustained steel price rebound.
One of the quirks of investing in commodity companies, and steel in particular, is that you typically want to own the inferior companies during the up-cycles. While pretty much every steel company saw share price improvement in the 2016-2018 upswing, names like ArcelorMittal (MT) and U.S. Steel (X) outperformed generally better-regarded names like Steel Dynamics (STLD) and Nucor (NUE) (though Steel Dynamics did quite well). Since the peak of steel prices, the script has flipped and ArclorMittal and U.S. Steel have noticeably lagged those other names.
I believe this second quarter will likely mark the bottom of the cycle for shipments, but I believe pricing could be lower for longer, which complicates positioning for the cycle. Lower-quality companies tend to do better when steel prices bottom and rebound, and that may not happen for several years. Consequently, while ArcelorMittal shares do seem to be trading at a very low valuation, even in the face of deteriorating near-term results, the uncertain timing of a sustained rebound in steel prices makes this a tougher call.
Mediocre Results As Demand Starts To Fade
While ArcelorMittal didn’t face the full brunt of Covid-19-related demand shifts in the first quarter, it certainly saw the start of the process. Overall results weren’t that good, with revenue missing by about 6%, and while EBITDA did beat expectations by 12%, there were non-operating items that helped (operating results were weaker).
Revenue fell 23% from the prior year and 4% from the prior quarter, driven in almost equal parts by weaker shipments (down 11% and 1%) and weaker realized pricing (down 14% and 5%). Only the NAFTA region saw sequential revenue improvement (up 7% on 10% volume growth), while Brazil declined 16% (shipments down more than 13%), Europe declined 5% (shipments flat), and ACIS declined 11% (shipments down 12%). Mining revenue also declined 10% qoq, led by a double-digit decline in iron ore shipments.
Results were more mixed at the EBITDA line, with overall EBITDA down 41% yoy but up 5% qoq with a modest improvement in margin on a sequential basis and a 23% sequential improvement in steel EBITDA per tonne (albeit from a very depressed level). EBITDA in the NAFTA region improved 77% sequentially, with margin just below 6%, while Brazil fell 9% (margin just below 14%), and Europe rose 29% (margin below 3%). Mining remained quite profitable, with EBITDA down 1% and margin coming in at 30%.
ArcelorMittal did do fairly well in terms of cash flow and liquidity, with net debt coming in at about $9.5 billion. The extent to which the company will see meaningful working capital release (boosting FCF) is a key unknown over the next 12 to 18 months.
Bracing For The Downturn
While ArcelorMittal management echoed the same challenges in forecasting mentioned by most other companies, they did express their belief that the second quarter could be the trough.