Seeking Alpha
Profile| Send Message|
( followers)  

Arcelor Mittal (MT) is among the leading steel and iron producers around the world. Established in 1989, the Luxembourg-headquartered company has grown into a global steel giant. Arcelor Mittal operates as an integrated steel and mining company, with interests in several iron and coal mines around the world. Arcelor Mittal is a strategic partner for many large industrial manufacturers, as it supplies one-fifth of the global automotive market's steel needs. However, the oversupply concerns in the steel and coal markets have negatively affected investor sentiment. While MT returned 10% this year, the stock lost almost 44% during the last 12 months.

As of the time of writing, Arcelor Mittal was trading at $19.78 with a 52-week range of $14.77-$37.69. It has a market cap of $31.4 billion. The trailing twelve-month P/E ratio is 22, and forward P/E ratio is 6. P/B, P/S, and P/CF ratios stand at 0.6, 0.3, and 18.3, respectively. Operating margin is 5.2%, and net profit margin is 2.4%. The company has an okay balance sheet, with low debt. Debt/equity ratio is 0.4. Arcelor Mittal is a nifty dividend payer. Based on a quarterly dividend of 19 cents, the stock's current yield is 3.8%.

Arcelor Mittal has a 5-star rating from Morningstar. Out of 10 analysts covering the company, 3 have a strong buy, 5 have buy, and 2 have a hold rating. Wall Street has diverse opinions about the company's future. The average five-year annualized growth forecast estimate is 11.4%.

So what's the fair value of Arcelor Mittal, given the forecast estimates? We can estimate Arcelor Mittal's fair value using discounted earnings plus equity model as follows.

Discounted Earnings plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary to many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.

E0 = EPS = ($0.87 + $3.30) / 2 = $2.09

Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 11.4%. Book value per share is $19.78. The rest is as follows:

Fair Value Estimator

V (t=0)

E0

$2.09

V (t=1)

E0 (1+g)/(1+r)

$2.09

V (t=2)

E0((1+g)/(1+r))2

$2.10

V (t=3)

E0((1+g)/(1+r))3

$2.11

V (t=4)

E0((1+g)/(1+r))4

$2.12

V (t=5)

E0((1+g)/(1+r))5

$2.12

Disposal Value

E0(1+g)5/[r(1+r)5]

$19.30

Book Value

BV

$36.60

Fair Value Range

Lower Boundary

$32

Upper Boundary

$68

Minimum Potential

61%

Maximum Potential

246%

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Arcelor Mittal is between $32 and $68 per share. At a price of $19.78, Arcelor Mittal is trading at a significant discount. The stock has at least 61% upside potential to reach its fair value.

Peer Performance

While most steel & iron companies have similar business profiles, their performance in the stock markets show some discrepancies. Compared to its U.S.-headquartered peers, Arcelor Mittal ranks among the worst performers in the market. Only U.S. Steel (X) performed worse than Arcelor Mittal. U.S. Steel's market cap was slashed by more than 50% in 2011. Even after returning 11.5% in this year, its annual performance was -45%.

Nucor Corporation (NUE) suffered the least damage from negative investor sentiment on steel companies. Steel Dynamics (STLD) ranks somewhere in the middle of the group with annual returns of -20%. Based on the price to free-cash-flow ratio, Cliffs Natural (CLF) is the cheapest steel producer, as it is trading with a P/FCF ratio of 7.80.

Performance Report

Company

Week

Quarter

Half Year

Year

YTD

Cliffs Natural

-1.74%

11.43%

29.23%

-24.42%

13.96%

Arcelor Mittal

-4.72%

10.78%

33.02%

-43.44%

9.71%

Nucor Corporation

-2.44%

10.08%

40.87%

-3.42%

9.05%

Steel Dynamics

-2.40%

14.61%

45.10%

-19.88%

11.56%

U.S. Steel

-0.03%

18.63%

35.68%

-45.25%

12.57%

The companies in this list offer yields that range from 0.67% to 3.8%. U.S. Steel is the lowest yielder among its peers. Note that Arcelor Mittal is not the only steel company trading at a discount. Almost all the companies in this list are trading at single-digit forward P/E ratios. Nucor is the only one that has a double-digit forward P/E ratio of 10.52. Based on book value, MT is the cheapest steel producer with a P/B of 0.54. It is also trading with the lowest debt/equity ratio.

Click to enlarge

Technicals

From a technical perspective, Arcelor Mittal is trading at an upward sloped channel. At the current valuation, it is trading near the middle of its 52-week range. The stock started the new year with strong bullish momentum, but it could not stay above $24, and retreated; $16 looks like a strong support level.

Summary

Based on the historical valuation metrics, Arcelor Mittal is trading at a discount. The trailing P/E ratio of 22 and P/B ratio of 0.5 are significantly lower than the 5-year average P/E ratio of 128, and P/B ratio of 1. Compared to the market's forward P/E ratio of 13.4, MT is significantly undervalued. The stock looks like a deep bargain, as it is trading with a forward P/E of 5.99.

Steel companies are among the few losers of 2011 that failed to bounce back this year. Therefore, they could be good contrarian picks. Based on my FED+ valuation, MT is undervalued by almost 40%. The stock has at least 61% upside potential to reach its fair valuation range. Analysts also agree with me. While not as bullish as the model suggests, their target price of $28.47 suggest almost 50% upside potential. Note that, similar to other commodity producers, Arcelor Mittal's future growth is determined by its primary commodity output. If steel prices collapse, then MT might also suffer.

Source: Arcelor Mittal: More Than 60% Upside Potential