ArcelorMittal: Accretive Ilva Deal Accelerates The Bull Case
Dec. 08, 2020 8:57 AM ETArcelorMittal (MT)1 Like
Opal Investment Research profile picture.
Opal Investment Research
ArcelorMittal is reportedly moving closer to a deal with the Italian government for Ilva/AM InvestCo Italy.
Considering the challenging economics at Ilva, the proposed deal is likely to prove accretive.
Should the deal go through, ArcelorMittal's deleveraging and capital return prospects look set to improve considerably.
According to a recent Bloomberg report, a deal between ArcelorMittal (MT) and the Italian government for its Italian steelmaking asset, Ilva, is currently in the works. Under the proposed terms, the government will be receiving a 60% stake in the asset, while MT benefits from the cash payments and a likely accretive outcome. I view the news as a positive, considering it adds to the deleveraging and capital return potential at MT. Overall, as the leading global steelmaker, MT remains my preferred play in the steel market.
A Glance at the Updated Deal Terms
ArcelorMittal and the Italian government have reportedly agreed to a new framework governing Ilva's ownership and operating outlook. Under the new terms, the Italian government investment agency (Invitalia) will take on a 60% stake in ArcelorMittal InvestCo Italy (also known as Ilva) in return for c. €1.2 billion in total payments.
Initially, Invitalia will assume a 50% stake in ArcelorMittal InvestCo in fiscal 2021 through a €400 million capital increase, after which it will lift its stake to 60% with a payment of €800 million in fiscal 2022 when the ArcelorMittal InvestCo's lease & purchase agreement ends. The JV's Board will consist of three members from Invitalia and three from MT. Invitalia will choose the Chairman, and MT will choose the CEO. The deal is expected to be finalized in the upcoming weeks.
Ilva Remains a Financial Challenge
According to recent reports, Ilva's current production run-rate stands at c. 7,000tpd or the equivalent of 2-2.5mtpa. This is below the revised production target of 8mt outlined at MT's new industrial plan presentation in FQ1 '20. However, considering AM Italia is planning to restart a third blast furnace with c. 2-2.5mtpa of design capacity, Ilva appears to be on track to hit its targets in the medium to longer term.
Source: ArcelorMittal FQ1 Presentation Slides
Considering current EBITDA/t targets stand at US$50/t (the equivalent of a c. $400 million uplift assuming 8mt capacity) at the group level, Ilva remains a drag at the current "much more neutral rather than negative" EBITDA. Note that this also includes benefits from the government furlough scheme, without which EBITDA would likely have been negative. This follows from the fiscal 2019 results when Ilva generated an EBITDA loss of c. $0.6 billion. Nonetheless, Ilva could still see profit generation in fiscal 2021, assuming current prices remain intact, and it benefits from a volume uplift.
From a balance sheet perspective, Ilva remains a considerable cash drain – MT is spending c. $250-300 million in capex/year and incurs quarterly rental payments of c. €23 million (following a 50% reduction). Combined, this equates to cash burn at Ilva at over $400 million/year. Added to this is the remaining lease liability of c. $1 billion, which also detracts from the balance sheet strength.
A Likely Accretive Outcome
At first glance, I think the Ilva deal will benefit MT. The deal, if confirmed, would not only enable the company to deconsolidate a significant amount of liabilities (AM InvestCo's $1 billion) but also reduce c. $250-300 million in capex per year. The net effect is likely to be accretive, considering Ilva's current EBITDA breakeven status, and should, in turn, also boost equity value going forward. Additionally, the deal also accelerates deleveraging – the potential receipt of c. €400 million in cash payments and the deconsolidation of c. $400 million in negative free cash flow should strengthen the balance sheet. As MT also maintains control of production/marketing of ILVA's steel, the retention of c. €300 million in synergies should also prove beneficial.
Finally, locking in the support of the Italian government, with the furlough scheme also likely to be extended, should benefit the competitive positioning. The risk of new entrants will be neutralized, and the prospects for disruption will also be significantly reduced going forward. This should allow MT to maintain a foothold in the Southern European steel market. Nonetheless, pending further details around the funding for Ilva's new industrial plan, including investments in low-carbon steelmaking and the construction of an EAF, it is hard to gauge the extent of the potential accretion.
Encouraging Deleveraging and Capital Returns Prospects
Assuming MT delivers in accordance with the Aperam (OTC:APEMY) playbook (as highlighted by management on the FQ3 conference call excerpt below), I think MT could see its dividend yield rise considerably. Recall that Aperam has returned c. 90% of its FCF since its leverage ratio (net debt/EBITDA) moved below 1.0x. However, I would point out that the payout would have been even higher if the fiscal 2020 buyback of €100 million, which was canceled due to COVID-19, had materialized.
"And as you heard, we will be announcing our full policy in February. Clearly, we have flagged this in the past, that we want to be on a path to delever and then return cash to shareholders. If you look at Aperam, a sister company, we have a good record in terms of demonstrating how we are returning cash to shareholders."
In line with the Aperam case, I see MT driving a staggered increase in its payout ratio to c. 80% by fiscal 2024, which would imply c. $1.5 billion in annual dividends and a c. 7% yield based on the current share price. Assuming the Ilva deal goes through, I think MT should also benefit from a stronger enough sheet, with net debt-to-EBITDA also likely to move below c. 1.0x.
In sum, MT remains my preferred play on a steel recovery, considering its status as the leading global steelmaker with operations in most major regions. A sustained focus on deleveraging and an accretive outcome from the Ilva deal should drive higher capital returns, along with a transition toward an FCF-based payout policy going forward.