As the world's economy continues to recover from the global financial crisis of 2008, the steel industry has been increasingly on my radar screen. 2013 is starting out to be a good year for some steelmakers, specifically those with U.S. or Chinese operations. But steelmakers with European operations will not likely fare as well.
Steel pricing and steel production levels are definitely metrics to review when analyzing regional and global economic recoveries and prospects for future growth. I see the steel industry as a basic building block of regional, if not global economic recovery. As regions of the world recover, the steel industry will be one of the first industries to benefit. This is already happening in the United States and China.
I've been focused here at Seeking Alpha on several China based steelmakers, who have good growth prospects, Sutor Technology Group Limited (SUTR), China Industrial Steel (CDNN.OB) and China Gerui Advanced Materials Group (CHOP). I've also identified Nucor Corp. (NUE) as being well positioned for future growth in the United States, as the economy improves.
Last year market conditions worldwide made it a tough year for most steel producers. Steel prices were depressed for most of 2012. Reduced demand for steel and erratic iron ore prices impacted many producers.
A huge excess of steel producing capacity in certain countries, specifically euro zone countries, has been, and is continuing to be a major problem for producers with European operations. Europe is without question the most problematic region for steelmakers.
It has been estimated that European demand for steel will decrease by around 4% this year, following a decrease of 3% last year. In 2011 145 million tons of steel were produced in Europe, which corresponds to about 71% of European steel manufacturing capacity. Steelmakers with significant European operations that should be on investors' watch-lists include ArcelorMittal (MT) and ThyssenKrupp (TYEKY.OB).
European governments will likely continue to pressure European steelmakers to keep steel production facilities open, and not downsize their European operations. Steel mills are big employers, and high levels of European unemployment will continue to affect European countries and governments. Threatened French government action has most recently impacted the French operations of ArcelorMittal. But European governments are likely putting off the inevitable, the need to drastically shrink European steel production capacity.
When one takes a look at the global steel industry, a good starting point is to take a look at the world's largest global steelmaker, ArcelorMittal. The company is the world's leading steel and mining company based on volume. The company is also the leading supplier of steel products for a number of industries including the automotive, construction, household appliance and packaging industries. The company operates in 60 countries and employs about 260,000 people. But, the global steel industry is fragmented, and ArcelorMittal accounts for only about 6% of global steel volume.
The ArcelorMittal conglomerate was put together by Lakshmi Mittal by consolidating what for the most part were struggling steel mills starting in the early 2000s. He took on debt as he grew his steel empire. In recent years, especially since the global financial crisis of 2008, the ArcelorMittal business model has proven to be problematic, especially as the European steel market has collapsed.
One has to wonder how a company the size of ArcelorMittal could have gotten itself into a position of having as many significant problems as the company now has. The company is definitely fighting a number of battles on a number of fronts.
Regaining its Investment Grade Status
As a steelmaker with huge European operations, ArcelorMittal, is in a battle to regain its full investment grade status.
The company reported a loss of $709 million in the third quarter of 2012. The company has a $23.2 billion market capitalization, and since it's not profitable, there is no P/E ratio. The forward P/E for the year ending December 30, 2013 has been estimated at 19.32. The forward P/E seems very aggressive for a steel company, especially one such as ArcelorMittal facing the problems that it has. With the shares closing Friday at $17.58 and with the 52 week range for the company's shares being $13.28 to $23.62, one has to wonder why the company's shares are not trading at a new 52 week low.
On December 21, 2012, ArcelorMittal had its debt rating cut to BB+ from BBB- by Fitch Ratings. The downgrade followed Standard & Poor's decrease in its rating to junk status on August 8th, and Moody's Investors Service decrease in its rating on November 8th. In announcing its downgrade, Moody's warned that the company was at risk of breaching a covenant in a credit facility unless it reduced debt or increased profitability.
This past week, ArcelorMittal announced plans to raise $3.5 billion by selling new shares and convertible notes, as part of an overall strategy to cut its debt to around $17 billion by the end of June. It's hard to see how the company will be able to reduce its debt to the $17 billion level so quickly, in that the company's debt was at $23.2 billion at the end of September. But, it's obvious that Lakshmi Mittal is under pressure to quickly get his financial house in order. With the objective of instilling confidence for the $3.5 billion fundraising, the Mittal family, which owns about 41% of ArcelorMittal's stock, indicated that it intends to invest $600 million in the combined offering. I'm not sure how quickly other investors will step up to the plate. Time will tell.
Last week a group led by the South Korean steelmaker Posco announced that it had agreed to purchase a 15% stake in an ArcelorMittal controlled, high-quality Canadian iron-ore mining for $1.1 billion, as part of ArcelorMittal's strategy to reduce debt. It's likely that we'll soon see other announcements by ArcelorMittal regarding other asset sales.
There is also a consensus that ArcelorMittal will seek to sell more mining assets, as opposed to selling what it perhaps sees as its crown jewels, its steel manufacturing assets. Due to current overcapacity of steel manufacturing in many of the markets in which ArcelorMittal operates, selling mining assets right now is easier than selling steel manufacturing assets. Today it's easier to sell mining properties at a reasonably good multiple than to sell steel manufacturing assets, at what today might be fire sale prices. But concerns have been raised that ArcelorMittal may end up having to sell some of its best steel manufacturing assets in order to regain its investment grade status.
Problems in Europe
Steel demand in Europe fell approximately 8% in 2012, which brought the cumulative decline in European steel demand since 2007 down approximately 29%. The Eurozone's weakening economy has eroded demand and left producers, including ArcelorMittal, with substantial excess capacity.
The euro region can produce about 210 million metric tons of steel a year, while demand under normal conditions is 150 million to 160 million tons per year, according to Eurofer, the European steel association. ArcelorMittal is among European steelmakers grappling with how to shutter unneeded furnaces, whose output is weighing on prices.
ArcelorMittal wanted to close two blast furnaces at Hayange-Florange in Loraine that were already idle, but wanted to continue to operate other facilities at the site. The French government had threatened to take what it said was temporary control, essentially nationalizing the plant to prevent the company from eliminating about 630 of 2,700 jobs at the site. Frances's Industry Minister Arnaud Montebourg told the French Parliament on November 28th that the government had found a potential buyer for the facility, which ArcelorMittal did not want to sell. But it's questionable whether this buyer really existed, and whether any buyer could be found, given the overcapacity of steel manufacturing in Europe.
The confrontation between France and ArcelorMittal became personal. Montebourg said, "We don't want Mittal in France." ArcelorMittal gave in, and announced that it was restarting one of the blast furnaces. But the company still has 10 of its 25 European blast furnaces shut down.
ArcelorMittal also indicated that it was taking a write down during the fourth quarter of 2012 of $4.3 billion tied to its European businesses. The company indicated that weak market conditions in Europe necessitated the write-down. At the same time, the company also indicated that its U.S. business was doing well and that steel consumption in the United States was up almost 8% last year, although still lagging behind 2007 levels by 10%.
But there was a general disappointment with the announcement in that it didn't include any hints as to further plant shutdowns. The only real solution to the structural and overcapacity problems of Europe's steel industry will have to be further plant closures, and there is a definite political component that may preclude ArcelorMittal doing what is really required to be done.
Also on the European front, India's Tata Steel (TATA) indicated on November 23rd indicated that it was closing 12 production sites and terminating 900 jobs in the United Kingdom.
As part of a strategy to enter the U.S. market, ThyssenKrupp, invested $11.8 billion in twin plants in Brazil and the United States. The company is abandoning that strategy. ThyssenKrupp is facing a shareholder revolt over what can be best described as a major debacle. The company is seeking bids for its Brazilian and American facilities by mid-February, and it's possible that other bidders could emerge for at least the U.S. facility. ThyssenKrupp has indicated that it would select a buyer by the end of September.
While ArcelorMittal is seeking to reduce debt and try to deal with its European problems, the company submitted a $1.5 billion bid for the U.S. steel mill which is located in Alabama. Brazil's Cia. Siderúrgica Nacional submitted a $3.8 billion bid for that plant and a majority stake in the Brazilian mill as well, and Nucor Corp. also submitted a bid of $1.5 billion for the Alabama facility. It's questionable who ends up with the mill, but it's not likely to be Nucor.
ThyssenKrupp has 170,000 employees and had sales for its September 30, 2012 fiscal year of $63 billion. To date the company has recorded losses of $15.7 billion for the two plants. The company had been seeking its book value of $8.86 billion for the plants, corresponding to its cost less depreciation.
ThyssenKrupp's strategy was to link steel production in North America and South America to take advantage of lower labor and energy costs in Brazil, and what it indicated was a higher-value end-market in the United States. Unfinished steel slabs are manufactured at the $6.8 billion plant in Brazil and then shipped to the $5 billion plant in Alabama. Principal sales from the Alabama plant are to automakers located in the southern United States, including Daimler AG (DDAIF.PK) and BMW AG (BMW:GR).
While I remain bullish for the prospects of the global steel industry, my interest is with companies that are tied to the increasing steel demand and economic growth in China, and the slight improvement in economic growth and steel demand, driven by construction and automobiles in the United States.
With all its problems, I don't believe that ArcelorMittal is a buying opportunity right now. If the company could achieve a permanent reduction in its European operations, and regain its investment grade status it could, I believe, become attractive for investors.
Instead I'm focusing on steel producers in the United States and China, which I've discussed here at Seeking Alpha, who I think will have good prospects for 2012 and future years.
One of these steelmakers with Chinese operations is Sutor Technology Group Limited. The company manufactures and distributes finished steel products and welded steel pipes. For the three months ended September 30th, the company's revenues were $117.2 million, and its net income was a minimal $1.8 million. Both its revenues and net income were substantially down compared to the same quarter of 2011. But what is significant to me is that the company remained profitable for the quarter. We won't have the fourth quarter results for a while, but I'm betting that the company's revenues and net income will both substantially have increased. Its current P/E is 4.34, which to me is significantly more attractive than a forward P/E of 19.32 for ArcelorMittal.
China Industrial Steel Inc. produces and sells steel billet, steel plate, and steel bar. The company's products are primarily used by the construction industry and in large scale infrastructure projects, including roads and bridges. The company's steel plate is also utilized by ship builders and for pipelines. As I've discussed here at Seeking Alpha, the company could be considered to be an "orphan stock." The company is also well positioned to grow as the Chinese economy grows. It's also likely that more investors will start to have the company on their radar screens. China Industrial Steel's revenues for the first nine months of 2012 were $475 million, with a net income of $2.8 million. As was the case with Sutor Technology's revenues and income, China Industrial Steel's revenues and net income were down reflecting the overall softness of the Chinese economy during the first six to nine months of 2012. As I've also indicated here at Seeking Alpha, while a bit speculative, I believe it's likely that the company could return to, or exceed its 2011 revenues of $823 million and net income of $45.8 million. Its current P/E is also in the same range as that of Sutor Technology. With the company's operations in China, I believe that this company is more attractive for investors than ArcelorMittal.
China Gerui Advanced Materials Group is a China based, value-added steel producer. The company produces specialized cold-rolled steel products, which are not standardized, commodity items. Instead, the company manufactures specialized products based on specific customer specifications. China Gerui's customers include companies involved in food and industrial packaging, construction and household materials, electrical appliances and manufacturers of telecommunications wire. While the company's third quarter 2011 results were disappointing and down from the prior year, revenues were $56.1 million, and the company had a net income of $2.4 million. The company's P/E is 2.96, and with its niche market in China's steel industry, I believe that this company is more attractive for investors than ArcelorMittal as well.
Investing in smaller-capitalization companies, as well as investing in companies in emerging markets, including China, is not suitable for all investors, and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risk.
The companies discussed above include a major global steel producer, ArcelorMittal. Investors should be cautionary regarding ArcelorMittal due to its problems in Europe and high debt levels.
Companies discussed also include smaller capitalization companies with Chinese operations. But the Chinese companies, whose shares trade in the U.S. are all U.S. reporting issuers, and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.
Disclosure: I am long CDNN.OB.