- ArcelorMittal is rapidly improving its balance sheet and could soon reach a zero net debt position.
- Meanwhile, the company is spending billions on share buybacks and will reduce its share count by over 20% in just over a year.
- Although 2021 will likely be a peak year, the much stronger balance sheet makes Arcelor still interesting at the current levels.
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It has been a while since I last discussed ArcelorMittal (NYSE:MT) here on Seeking Alpha and although the stock was sold from the Nest Egg Portfolio at 24 EUR earlier this year, I’m still keeping an eye on this steel giant. The steel sector is enjoying massive tailwinds and after looking back at Algoma Steel (ASTL) in this recent article, it only makes sense to have a look at how ArcelorMittal is doing these days.
The Q3 free cash flow result was phenomenal
Arcelor actually posted the best quarter since 2008 and despite shipping about 9% less steel, the EBITDA increased by approximately 20% to in excess of $6B while the net income came in at $4.6B, which also is the highest quarterly performance since 2008.
The total revenue exceeded $20B, and the operating income of $5.35B indicated an operating margin of in excess of 26%. Much higher than in the preceding quarter where the operating margin was ‘just’ 22.9% (which is obviously still good), despite recording about $123M in exceptional items in the third quarter of the current financial year.
Source: financial statements
On top of that, Arcelor saw its income from associates and joint ventures increase as well (which does make sense as the tailwinds are an industry-wide thing and it’s obviously not just Arcelor benefiting from them) while the net interest expenses continue to decrease as Arcelor is rapidly reducing its net and gross debt while refinancing existing debt at lower interest rates. The bottom line shows a net income of $4.84B (including an $882M tax expense) of which approximately $4.62B is attributable to the shareholders of ArcelorMittal. This represents an EPS of approximately $4.17 based on the 1.11B shares outstanding on an average basis. However, ArcelorMittal is continuously buying back its own shares on a very aggressive basis and investors could expect the share count to continue to drop which will further fuel the per-share performance.
On November 17 th, Arcelor announced a fifth buyback program for a total of $1B as the company wants to make sure it enhances the value for its shareholders by using its very strong free cash flows by reducing the share count. The $1B additional buyback program should be completed within three months and considering the steel industry remains pretty strong I don’t think we should be surprised if we’d see additional buyback plans. In the period of November 17 to November 26, ArcelorMittal already spent $380M on the share buybacks as it repurchased 12.7M shares. I wouldn’t be surprised if the additional buyback would be completed before the end of this year. Expect the share count to drop to less than one billion shares throughout 2022 and that would be about 20% fewer shares outstanding compared to Q3 2020.
Source: company presentation
As Arcelor is spending a lot of cash on these buybacks, we have to make sure the company’s cash flow performance is sufficient to actually fund these buybacks. We obviously saw the net income of ArcelorMittal is excellent, so I had high hopes for the free cash flow result as well.
As you can see in the image below, Arcelor reported an operating cash flow of $2.44B, but this includes a $2.9B investment in the working capital position, but excludes the $46M in lease payments and the $157M in dividends paid to minority shareholders. Adjusting the result for these elements, the adjusted operating cash flow in the third quarter was approximately $5.15B.
Source: financial statements
As you can see above, the total capex was just $675M, resulting in a free cash flow result of just under $4.5B. This indeed confirms the company’s net free cash flow is pretty similar to the reported net income and the small difference is caused by a slightly higher capex versus depreciation expenses.
The balance sheet is now rapidly improving
So while ArcelorMittal is aggressively buying back stock ($1.7B in Q3 and about $3.4B in the first nine months of the year), this doesn’t go at the expense of the balance sheet. In fact, the net debt is continuously being reduced by ArcelorMittal.
Source: company presentation
In fact, the current debt ratio (net debt versus the trailing twelve month EBITDA) is less than 0.25, a massive improvement compared to the 1.5 ratio as of the end of last year (although we should obviously be mindful the weak performance in the first few quarters of 2020 weighed on the full-year EBITDA result).
This means that there’s absolutely no issue for ArcelorMittal to continue to spend its cash on shareholder rewards and additional decarbonization and expansion programs.
Source: quarterly report
I currently don’t have a position in ArcelorMittal anymore, but it’s impossible to deny the company’s 2021 performance will be absolutely stellar. The adjusted free cash flows will remain strong in Q4 and likely in Q1 as well, and as Arcelor is expecting a working capital release, the net debt will continue to fall off a cliff and could soon reach zero. As the company continues to buy back stock, I think it’s very likely ArcelorMittal will end the year at an enterprise value of less than $30B.
That makes the stock extremely cheap right now, at just around 1.5 times the annualized EBITDA. Of course, we are now likely getting close to the peak of the current cycle and I expect the EBITDA and free cash flow to show a gradual decline from next year on (notwithstanding the higher infrastructure spending planned in some of Arcelor’s main jurisdictions), but Arcelor took advantage of the tailwinds this year to rapidly reduce its net debt and prepare its balance sheet for some tougher times.
I may consider writing (out of the money) put options on ArcelorMittal again, but I haven’t made a decision yet.
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The Investment Doctor is a financial writer, highlighting European small-caps with a 5-7 year investment horizon. He strongly believes a portfolio should consist of a mixture of dividend and growth stocks.He is the leader of the investment group European Small Cap Ideas which offers exclusive access to actionable research on appealing Europe-focused investment opportunities not found elsewhere. The a focus is on high-quality ideas in the small-cap space, with emphasis on capital gains and dividend income for continuous cash flow. Features include: two model portfolios - the European Small Cap Ideas portfolio and the European REIT Portfolio, weekly updates, educational content to learn more about the European investing opportunities, and an active chat room to discuss the latest developments of the portfolio holdings. Learn more.
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