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Despite the recent steps taken by the Brazilian government to spur the country's depressed infrastructure, we remain cautious about Brazil's steel industry, and don't feel that the present is an appropriate entry point. The industry is suffering from reduced demand, price drops, and high raw material costs; although import tariffs have been recently increased. Consequently, despite its 7% dividend yield, we are not bullish about Companhia Siderrgica Nacional (NYSE:SID) due the prevailing industry dynamics, and the expected increase in leverage if the company's able to acquire the ThyssenKrup's steelmaking unit.

Brazil: Impending Infrastructure Boom

The country's woeful infrastructure has been the major source of problems for the otherwise progressing nation. However, the country's president, Dilma Rousseff, has recently announced a plan, according to which the government would give licenses worth $66 billion for roads and rails to help bolster growth in the country. We consider steel companies like CSN one of the prime beneficiaries of this plan, which aims to help solve infrastructure challenges that the country has historically faced.

Brazil: Steel Industry

We consider Brazil's Steel Industry to be highly volatile, at least till the end of this year, just like what we think about the global Steel Industry, where the weakness is expected to persist in the near term. According to Instituto Aço Brasil (IABr), Brazilian steel production has suffered a 6.3% YoY drop in August as oversupply concerns, high raw material costs, and high imports continue to pose problems for the industry, in addition to the global problems of low demand and depressed prices.

Consequently, IABr might have to cut steel production estimates for this year. However, the government has recently increased import tax so as to protect domestic steel mills, which we expect will act as a temporary relief for an otherwise volatile sector.

Brazil: Monetary Stimulus

Previous, monetary easing steps by the country's central bank to bolster economic growth have had the undesired impact of raising expected inflation to 5.3%, way beyond the bank's target of 4.5%. If the central bank acts to stymie inflation, it can have a further downward impact on steel prices.

Companhia Siderrgica Nacional

Companhia Siderrgica Nacional - or CSN, for short - is the third-largest Brazilian steelmaker by output. It is primarily an integrated steel producer in Brazil and Latin America, along with being the second largest producer of flat-steel products in Brazil.

The Sao Paulo-based steelmaker posted its first quarterly loss in at least three years as a result of both a revenue drop and expenses hike. However, it expects coal and iron ore costs to decrease in the upcoming quarters, which will help the company return to profitability.

Possible Acquisition?

CSN has recently hired the investment banking unit of Banco Bradesco so as to seek advice on a potential bid for ThyssenKrup's steelmaking unit, known as Steel Americas (CSA). According to a recent client note by Barclays PLC (NYSE:BCS)'s analyst, Leonardo Correa, "CSA is among the highest-cost slab operations in the industry, generating significant operating losses under current market conditions."

Lorrea also believes that CSN appears to be the most likely candidate to acquire CSA. However, he expressed concern that the buyer of the asset will have to burn cash/invest so as to re-shape operations and generate profits. In addition, CSN will have to face higher leverage ratios (with net debt to EBITDA amounting as high as 5x-6x), which is also one of the reasons why we are not excited enough about this possible acquisition.

Upcoming Catalyst

CSN expects to start operating a long steel plant in Volta Redonta by June 2013. According to management estimates, the share of the products designed for the construction market is going to increase from 20% in 2011 to 35% of total sales volume in the upcoming two years. So, it might be a good option for those investors who are targeting a potential upside in Brazil's construction market.

Valuation

The following table shows the valuation metrics for CSN and its Latin America peers, Gerdau S.A. (NYSE:GGB) and Ternium S.A. (NYSE:TX), as compiled by Barclays.

CSN

Gerdau

Ternium

EV/EBITDA (2012E)

7.5x

9.5x

2.9x

P/E (2012E)

N/A

17.9x

5.8x

FCF Yield (2012E)

-4%

-3%

-7%

Dividend Yield (2012E)

7%

1%

0%

Net Debt / EBITDA (2012E)

3.8x

2.4x

1.0x

Source: Why This 7% Dividend Yielder Is Not Worth The Risk In The Short Term