ArcelorMittal (MT) is the largest steel maker in the world. Its current market capitalization sits at $23 billion. Recently the market has knocked down shares of the steel maker and has priced the shares well below their March 2009 level. Shares are trading at $15, a level not seen since July 2004.
The company is located in Luxembourg and has a significant portion of their operations in Europe. With the recent European crisis unfolding, it makes sense that the market has been discounting shares heavily. However, the real question investors need to ask themselves is if the decline has priced in a European recession.
Let's go over the market's concerns:
- European default and potential recession
- ArcelorMittal has a high level of debt
- Labor unions plan on organizing a strike due to layoffs and factory closing
- Defense cuts means lower demand for steel
A European default and a global recession would surely cause the steel industry to take a massive hit. After all, who is willing to construct new buildings and facilities in a recession? Auto manufacturers have already begun to see a slowdown in sales. Ford (F) recently closed down several manufacturing plants in Europe due to a decrease in demand. It's also interesting to point out that Ford awards ArcelorMittal the supplier of choice.
However, a European default will not necessarily impact ArcelorMittal the way the market is predicting. Even though ArcelorMittal gets a significant amount of its revenue from Europe, the company is being priced for not only a global recession, but also it seems as if the market is saying the company will be unprofitable for years to come. This is a misconception as ArcelorMittal is one of the best managed companies in the world. One large benefit that ArcelorMittal has over other smaller steel producers is the high number of steel manufacturing units the company owns in various locations in Europe. The units are most profitable when they produce an optimum amount of steel to balance the fixed and variable costs; the company can stop production in Europe while increasing the production level at other units to reduce overall expenses and improve margins.
Going back to our Ford scenario, hypothetically speaking assuming that the company completely stops production of automobiles in the world (an unlikely scenario), ArcelorMittal would not get significantly affected. This is because ArcelorMittal is the largest steel producer in the world and no single customer makes up a significant amount of its revenue.
Another concern that has been brought up by short sellers is the debt level. Shorts have been saying that the company is highly leveraged and if the company becomes unprofitable then this could cause an issue. I believe the company is less leveraged than its peers. Let's look at the debt levels of its peers as well.
ArcelorMittal - 41.6
Posco (PKX) - 56.9
U.S. Steel (X) - 97.7
So just in comparison to its peers its debt/equity is less than its biggest competitors. A few other important things to keep in mind: ArcelorMittal is not only larger than Posco and U.S. Steel, but it is also much more diversified. U.S. Steel has all of its exposure to America and Canada, while Posco has most of its operations in Asia. In these turbulent times, it's better for a company to diversify in order to avoid regional problems.
ArcelorMittal is also under attack from labor unions in Europe. This is due to layoffs and plant closings. Workers are striking since ArcelorMittal has shut down 9 of its 25 furnaces. The company stated that in these uncertain times they cannot keep producing steel. Even though this situation is unfortunate for the workers, the company has made the right decision. They understand if they keep producing it will drag down their margins and take a toll on their bottom line.
The last issue many have brought up is the massive defense budget cuts that are expected to take place in the U.S. Due to the ongoing debt crisis, defense cuts are inevitable. The supercommittee will likely cut in this area and this would mean a lower demand for steel. However, just like I stated earlier in this article, no single industry or company accounts for a signicant portion of the company's revenue. It is very clear that any LARGE defense cuts WILL have a material impact on ArcelorMittal, but the valuation suggests far worse. So let me get to my last point on why ArcelorMittal is still a buy.
ArcelorMittal clearly has its fair share of problems, but management has done a fantastic job of efficiently cutting cost to maintain profitability as well as idling production in key areas. The market is right in saying that a European recession and defense cuts will all take a toll on ArcelorMittal. However, I believe the amount they predict is wrong.
As a value investor, one of the biggest metrics I love to use is net tangible assets. Basically it is the physical value of the company. Its net tangible assets is $48 billion, which is interesting considering that the company's market cap sits at just around $24 billion. So the market has given a 50% haircut to the company and expects the company's future to be very grim. The real question is will ArcelorMittal lose $24 billion of value over the coming years? I believe the answer to be no, as the company will still continue to maintain profitability.
If we look at Posco it is trading only 11% under tangible book, while U.S. steel is trading 2x tangible book. It's also important to note that U.S. Steel is still not profitable and can be very inconsistent in terms of profitability.
ArcelorMittal is the largest steel manufacturer in the world with operations around the world. Even though the company has its fair share of problems, it trades at 50% of its physical value. The company trades at a forward P/E of 6.4 and pays a 4% dividend, making it a good play for income investors as well. I also believe the dividend to be safe from any cuts.
Disclosure: I may sell a Jan 2012 put at the $14 strike. Investors should consider this option as well as it allows you to collect a decent premium, while waiting for a lower price.