ArcelorMittal (NYSE:MT) will release its fourth-quarter earnings Wednesday, Feb. 6. The company had a very eventful quarter consisting mostly of bad news. Moody's downgraded its debt rating due to its large debt burden and doubts about the company's ability to service it in the face of challenging market conditions. Then it found itself embroiled in a highly publicized political row in France over the proposed closure of some blast furnaces at Florange. In December, the company announced that it would write down the value of its European business by about $4.3 billion in the fourth quarter because of the economic downturn that has resulted in gloomy prospects for steel manufacturers in the region.
Given the challenges in the steel industry, we expect a weak earnings report.
Market Conditions Are Unfavorable
The automotive sector in the U.S. remains strong and the growth rate in production is expected to be in the double digits in 2013. The U.S. construction sector is also picking up from as home sales have been rising, and the trend is expected to continue through 2013. In Northern Europe, output has decreased due to the continuing uncertainty over the debt crisis. In Southern Europe, the recession is deepening as austerity measures are being extended, and this is causing consumers to cut back on spending and thus construction demand is weakening. The situation is particularly dire in Portugal, Greece, and Spain.
According to ArcelorMittal, demand for steel in Europe has fallen by 8% this year alone and by around 29% since 2007. Austerity measures implemented by governments have lowered the demand for steel in the automotive and construction sectors. These two segments are the major customers for steel. The steel manufacturing capacity in Europe stands at around 210 million tonnes, of which only 155 million tonnes is being utilized at present.
Given that countries in Europe accounted for nearly 48% of ArcelorMittal's revenues in 2011, trouble in Europe has a considerable impact on the company. The recent $4.3 billion writedown in the European business bears testimony to this.
The slowdown in China also caused considerable pain in the first three quarters in 2012. However, in the fourth quarter things began looking up, probably due to the infrastructure related spending by the Chinese government. Iron ore prices firmed up rapidly in the last quarter, as Chinese steel mills began restocking in anticipation of higher future demand. Any positive impact on the prices of steel will likely be visible only in the first quarter of 2013.
Steel Prices to Weigh on Earnings
We expect average realized prices to decline across segments as steel prices on the London Metal Exchange (LME) are trending lower compared to the previous quarter. The unfavorable market conditions described above have contributed to the decline in steel prices on the LME.
Developing Countries Could be a Beacon of Hope
A worldwide economic recovery will benefit steel companies including ArcelorMittal. A lot of the negative sentiment already seems to be factored into the current stock price. If ArcelorMittal faces more problems in Europe, there could be a further downside in the short and medium term.
Until its economy recovers, we don't see demand for steel increasing substantially in Europe. ArcelorMittal is likely to place its bets on China and other developing countries, which are expanding and urbanizing at a rapid pace. According to ArcelorMittal's presentation at the Macquarie conference, compounded annual growth rate (CAGR) for steel stood at 5.6% between 2000 and 2010 in developing countries (excluding China).
We have a price estimate for ArcelorMittal of $15, which will be revised after the fourth-quarter earnings results are declared.
Disclosure: No positions.