Companhia Siderurgica Nacional: Global Growth Story

Editor's Note: Matt, a SINLetter subscriber and the recent winner of CNBC's Fast Money Contest, has contributed the following section of the newsletter. Matt is a consultant within the biotech industry and also a full time trader. I occasionally seek out his opinion on the pharma/biotech sector.

The Story

The price for steel, as well as iron ore, has seen extraordinary price appreciation in recent months.

Fueled by a seemingly insatiable demand for basic materials, developing nations are falling victim to the increase in pricing power by global steel makers who have been consolidating over the last few years. Even raw iron ore commodity prices have surged as high as 65%, in which South Korean steel maker POSCO (PKX) and Japanese steel maker JFE Steel Corp have recently complied with Brazil's largest iron ore producer, Companhia Vale Do Rio Doce (RIO).

One of the few steel companies in prime position to benefit from this current environment trades on the NYSE is an ADR by the name of Companhia Siderurgica Nacional (SID).

Founded in 1941, SID is a fully integrated Brazilian steel company that as the name implies used to be a state-owned company until 1993. Full integration means that SID can not only produce steel products that are in high demand, but also owns iron ore mines, railroads, and sea ports. This makes SID supremely positioned to support the increasing steel demand in Asia, the Middle East, and even its own governmental demands for increased infrastructure and urbanization.

The primary benefit of this integration will undoubtedly be its ability to tolerate, if not ignore, the cost of goods impact from the increase in iron ore prices.

This could give SID a dramatic advantage on the international steel market by undercutting other steel manufacturers thanks to lower than industry averages in basic raw materials (i.e. iron ore). Ostensibly, this sort of lowball price war is highly unlikely in the short term thanks to strong global demand, but provides SID with a several advantages rarely seen thanks to a higher than normal profit margin potential compared to it’s competitors.

Numbers and Valuation

The chart below (click to enlarge image) certainly proves that SID has richly rewarded investors during the last 12 months with a 184% return. However, despite these returns, the company trades at a trailing P/E of 19.36, a P/S of 4.94 and a very attractive forward P/E of just 10.15 (according to Yahoo Finance). Net income increased an astounding 150% to $1.64 billion in 2007 and revenue increased 27% to $ 6.44 billion.

The forward P/E of 10.15 is indicative of a strong growth stock and would not (at least to this investor) suggest price appreciation is over. Growth rates for 2008 are expected to be in the 35% to 50% range, which differ among analysts covering the stock, but this could be due in large part to the frequent changes in short term steel prices.

While the company had $2.71 billion in debt on its balance sheet at the end of 2007, net debt fell by 28% when compared to 2006. Declining interest rates in Brazil (they fell from 19.75% in mid-2005 to 11.25% before a recent 50 basis point increase) combined with declining debt should help SID’s bottom line in 2008. If you are interested you can find the 2007 annual report here (PDF) (Note: All numbers calculated using the Real/Dollar exchange rate of 1.771 from December 31, 2007)

Conclusion

Additional positives for SID include the increasing popularity of Latin American stocks (particularly Brazil) in the ETF market and Brazil likely reaching investment grade status (shortly before publishing this newsletter we came to find out that S&P has raised Brazil's credit rating to investment grade). While the US is at the brink of a recession, or already in one based on whom you ask, Brazil posted GDP growth of over 5% in 2007 and is expected to grow 5% in 2008. Therefore, SID is definitely worth serious consideration as a global growth story for 2008.

Disclosure: Matt has a long position in SID.

Comments

[dimensionalanalysisman]

great article on a company that has been getting very little credit/attention in the US. i have been long for 6 months and very excited about future prospects for SID.

[RichardSchweitzer]

Missing here are comments on: Principal markets (mostly export?) and sorces of smelting components other than ore, as well as energy for rolling and fabricating.

Good selection. Divesre products, many with excellent margins.