Buy ArcelorMittal On Improving Market Outlook, Strong Fundamentals

Feb. 5.14 | About: ArcelorMittal (MT)

ArcelorMittal (NYSE:MT) is involved in the mining and production of steel products. The company has six major segments, namely Flat Carbon Americas; Flat Carbon Europe; Long Carbon Americas and Europe; Asia, Africa, and CIS (AACIS); Distribution Solutions and Mining. The company has a total of 16 iron ore and coal mines in the operational and development phase. The coal mines help ArcelorMittal to reduce the costs for outside purchases of metallurgical coal. In 2012, the company produced 55.9 million tonnes of iron ore and 8.2 million tonnes of coal. It also has steel facilities in more than 20 countries worldwide and produces finished and semi-finished products for the automotive, appliance, engineering, construction and machinery industries distributed in approx. 170 countries. The company closed the third quarter of 2013 with a 6% increase in steel shipments compared to the same quarter of 2012, amounting to 21.1 million tonnes.

Fundamentals

The steel industry enjoyed the recovery of US economy after the economic recession hit during the end of 2008 as steel products are directly proportional to the economic growth; higher the economic growth, higher the demand will be of steel and vice versa. During 2009, production for steel fell by 8% year on year due to instable US economy. However, the steel industry showed recovery from 2010 onwards as their production increased by almost 16% year on year and then by 7% in 2011. However, with the US recovery slowing down after the improvement in the economy, the demand for steel has reduced while European countries also experienced their recession which affected their steel market and led to overcapacity in the whole industry. Steel is demanded by construction industry which reflects the trend of economic growth of the country; car manufacturers and mechanical engineering. Demand by car industry fell by 30% in 2013 after the production fell from 16 million units in 2006-07 to around 12 million in 2013. In Europe alone the steel plants are running at 70% capacity due to declining demand which is hurting the financial statements of companies like ArcelorMittal. With the increased production of steel and its low demand the prices started to decrease and high labor costs left the industry with little profit margins. Now the steel industry is trying to get back on their feet by controlling their production in order to reduce excess supply of steel in the market with the expectation of increase in world demand by 3.3% reaching a level of 1,523 million tonnes in 2014 after 3.1% increase in 2013.

Although some companies chose to manage the capacity issues by idling their facilities, this was not the case for ArcelorMittal. When the company merged in 2006 to become the biggest steel producer in the world it made an agreement with the European governments to maintain the same production and job levels which prevented it from cutting down its capacity. The French government even threatened to nationalize ArcelorMittal's Florange plant when the company was analyzing the option of cutting down jobs and the closure of two blast furnaces.

Click to enlargeThe income statement of the company does not paint a good picture as it has suffered a loss of $3.8 billion in 2012 and of $1.3 billion during the nine months ending on 30 September 2013. However, this is not an alarming situation as the company's EBITDA for nine-month period was almost $5 billion while non-cash costs; impairment cost of $140 million, depreciation of $3.4 billion and almost $1 billion loss on foreign exchange pushed the company to losses. In 2013, the company was unable to utilize its earnings as it closed the year with only a 0.39% increase in its share price. The first half of 2013 did not prove to be fruitful as there was a persistent decline in share price but the company recovered strongly later on. However, this changed when the company entered the new financial year with more decline, though this is not a troublesome issue as these are just short-term changes. This declining trend in the share price might have been due to volatile steel prices as the company does not have a diversified product line.

ArcelorMittal paid a dividend of $0.20 per share for a dividend yield of 4.63, which is more than double the industry average. Even though it indicates that the company has outperformed the market, at such a high level of dividends there is no room for further growth as the company reported cash outflow of $448 million from operating activities during third quarter of 2013. This indicates that the company will either continue to pay dividends at this level or it will decrease to match the industry. Another thing to note here is that this dividend was paid through long-term loans as the company's operating cash flow was negative indicating that it did not have the capacity to pay dividends from internally generated revenues.

Company

Industry

Sector

Quick Ratio (MRQ)

0.67

0.54

2.69

Current Ratio (MRQ)

1.40

0.98

3.35

LT Debt to Equity(MRQ)

39.25

34.79

17.60

Click to enlarge

The company is looking strong financially when compared with the industry but its quick ratio, at 0.67, is below the desired level of 1. However, this should not be of any concern for now because the company has $4.5 billion in cash and cash equivalents and also $10 billion in available credit line which can be availed by the company in any situation; either to finance their new project or to pay-off their short-term obligations.

ArcelorMittal has a high LT debt-to-equity ratio which might have been caused by the recent increase of $1.6 billion in its long-term debt in the third quarter of 2013 versus the second quarter of the same year. This debt increase was due to the payment of dividends, amounting $364 million, and an investment of $806 million in working capital. However, the company is expecting an improved operating cash flow for the last quarter of 2013 and with the proceeds from previously announced disposals it expects to bring down the debt level to $17 billion from $17.8 billion.

Recent Developments

ArcelorMittal has decided to reopen its Harriman plant which was closed in 2011 due to poor market conditions. This plant is expected to be operational in April 2014 and will not only create jobs but will also help the company to increase its production. The Harriman plant will be responsible for making light structural metal and merchant bars which will be sold to the construction market. This restart is being supported by United Steel workers and the local and state governments.

In October 2013 ArcelorMittal and Sider, an Algerian state-owned company, signed an agreement in which the company's interest will dilute from 70% to 49% and in return it will be given certain incentives including low-cost local bank financing. This agreement also includes an investment plan of $763 million for the development of a steel complex at Annaba and mines in Ouenza and Boukhadra which will increase the production of Annaba from 1 million tonnes to 2.2 million tonnes per year by 2017.

The company has also signed an agreement with Sishen Iron Ore Company Ltd. (SIOC), subsidiary of Kumba, in November 2013 which involves the long-term supply of 6.25 million tonnes of iron per year ore from Sishen. This deal will greatly affect ArcelorMittal's steel output by increasing the amount of raw material at the company's disposal and will also reduce mining related financial risk. The price of the iron ore to be traded has been decided to be the cost of mining (including capital costs) plus a 20% margin.

Valuation

Amounts in ($ Billions)

Market Capital

29.47

Long term Debt

18.5

Cash and Cash equivalents

(4.4)

Enterprise Value

43.57

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The company has an enterprise value of $43.57 billion according to our calculations. With 1665 million shares outstanding, we get an EV per share close to $26/share. However, currently the share is being traded at around $16.5 per share which indicates substantial room for improvement.

Conclusion

Shale gas is booming in the energy sector and providing access to more cost effective and environment-friendly fuel as compared to oil or coal. This will bring a big change in all the energy hungry industries, including steel, and ArcelorMittal can utilize this option by shifting to the cheaper and cleaner fuel. This will affect the financials of the company because energy is the biggest expense of steel producers, which in return will increase the profit margins. On the other hand, China's increasing economic growth gives hope to the steel industry as the current overcapacity, which has been haunting the whole industry, might be used up by China. Europe is also showing signs of recovery which may hasten ArcelorMittal's recovery. Therefore, the cheap valuations and an improving steel outlook makes ArcelorMittal an attractive investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Equity Flux is a team of analysts. This article was written by our Basic Material analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.