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ArcelorMittal: A Steel Leader
Jun. 8, 2020 12:29 AM ET|2 comments | About: ArcelorMittal (MT)
Summary
-An attractive alternative in a cheap industry.
-Reasonable debt structure under the hands of debt-conscious management.
-Interesting valuation that offers protection even for depressed cycle performance.
Why Steel
As of the end of May 2020, steel, together with banks, O&G drilling, some insurance businesses and fertilizers, is one of the cheapest industries in the market. Its performance in the last year has been negative, losing 20% of its market value.
The steel industry is trading at 10x earnings, a 20% discount to its book value and 6x 2019 EBITDA or 10x its 2020-21 estimated EBITDA.
The 20 largest steel companies as of that date are listed below. As we can see, there are significant differences in historical growth, margins, return on capital and current valuation, as measured by EV-to-EBITDA-LTM.
ArcelorMittal (MT) seems to be the cheapest company in terms of EV multiple to LTM’s EBITDA, which was the main reason to start looking into this company. Besides, it is clearly an industry leader able to capitalise into the consolidation that a crisis like the present one might bring.
Steel industry snapshot
The steel industry is not particularly profitable. There can be particularly good years, but the bulk of the returns on capital are going to be in a 5-15% range, and they can be volatile from one year to another. The main driver of return on capital is margin, rather than turnover on capital.
The ROCE of the industry, represented by those 20 largest companies (and MT following a similar path in the last 15 years), was clearly in a negative trend until 2010, when it reached less than 5%, and then had a gradual recovery until 2019, when it reached 15% just before the COVID induced crisis on production first and on demand afterwards.
MT is clearly not the best performer, especially with regard to EBITDA margin, but is able to keep up with its return on capital because is more efficient in turnover and in the control of maintenance capital expenditures.
Steel production is a certainly a complicated business:
It is close to a perfect commodity for many segments of the finished product. Besides, no matter how old is the article you read on steel or on what country, excess of capacity is always the main concern. Overinvestment and overcapacity cycles have developed in Europe and USA in the 18th and 19th centuries, and more recently in China. When overcapacity has been created, producers tend to demand protection from their governments, which only makes the problem persist, creating incentives to perpetuate it.
Cost production curve is almost flat, especially from $400-450 per ton. Cheaper producers are based in CIS, which is attributed (McKinsey) to low-cost captive raw materials access, a key reason for differences in cost of production per ton.
The main steel consumers - auto and construction - are themselves very cyclical, so steel demand is cyclical by nature. This adds volatility in the output volumes and prices.
The business is capital-intensive. It is estimated that the average investment per ton of raw steel production is $250-300. Since the OCDE estimates that global capacity as of end of 2018 was 2,234M tons, that means the total invested capital is c. $650 billion, and that is only in basic raw steel production.
Gains in productivity from technology are not huge, but they can be critical. This is an old industry, and while new little changes happen constantly, there have not been big game-changer technologies that have made all previous invested capital obsolete. There are two main production technologies that are selected based on the development of the producer country. When there is enough development, there is enough scrap product that can be re-melted using EAF, which is cheaper, cleaner and more efficient than BOF, which the classic technology used when iron ore needs to be used to produce raw steel.
The input costs - iron ore, energy either in the form of coke coal, electricity or natural gas, scrap and different alloys, etc. - are all also volatile and subject to their own independent cycles, and can suffer from local imbalances that add to global cycles.
The industry, many times voluntarily, is the focus of political intervention, regulation and protectionism practices that make management of steel companies even harder.
My view is that there is no way I will be able to have a view on what will be the short-, medium- or long-term evolution of steel prices, production, input prices, etc. Everything is too volatile and too fragmented to think of any investment in MT based on a reasonable estimate of the basic economic parameters for the industry.
On the other side of its sheer complexity, there is some inherent stability to steel. It is a product that will not disappear in the foreseeable future, as it is an essential product for everyday life products, and the range of uses and applications is enormous.
Therefore, my purpose will not be to make a guess on future steel price or future cost input prices. I find that impossible for my limited experience. My purpose will be to determine what is an average low point in the industry cycle and to build from there what could be a conservative valuation of the company.
A recap on ArcelorMittal's recent history
Mr. Mittal started his own business history in Indonesia in 1975 when he changed his father’s plan to sell an unnecessary land plot and decided to build a steel plant on the site. Later, he bought a plant in Mexico that the government had built for more than $2 billion but that was losing money year after year. The next big one was in Kazakhstan. In 1997, the family floated a 20% stake in part of the international steel business and kept the Indian and the Kazakh business within the family.
From the “public” platform, they made the first step in the US in 1998 with the acquisition of Inland Steel. By then, they controlled 2% of world steel production.
With the start of the century, the Chinese expansion brought excellent years for the industry, coupled with a consolidation effort in which Mr. Mittal had a clear leading role. Finally, the steel industry was putting more focus on profitability rather than volume.
According to this study done in 2008, the strategies pursued by different steel companies to survive and grow in what certainly is a difficult industry can be grouped into eight different categories, from capacity growth with competitive acquisitions and JVs to location strategies, vertical integration, niche focus, etc.
According to the analysis, Mr. Mittal showed in the company's ascent to the global steel pinnacle that it was possible to be active in most of those strategies at the same time. He picked a mixture of strategic (meaning expensive) acquisitions mixed with discounter strategies by picking near-to-bankrupt steel companies at bargain prices. The only strategy he did not seem to exercise was the joint venture route.