ArcelorMittal: Making Hay While The Sun Shines, Trading At 1.5X EBITDA

Summary

• 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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SlobodanMiljevic/E+ via Getty Images

Introduction

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.

Data by YCharts

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

Investment thesis

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.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[banmate6]

@The Investment Doctor

Here is my MT investment.

date shares total_price $/share
8-Jul-2015 133 $3,600.95 $27.01 basis
14-Jun-2018 0.335 11.3 33.73 div
13-Jun-2019 1.389 $22.67 $16.32 div
15-Jun-2021 $40.42 div

Nothing special. Easily beaten by the S&P500. Not a big investment, but I tend to nibble and see what happens. I knew this one would be cyclical, but I've waited many long years. It kept up with inflation, but that's become an issue for the time being...and you'd think a commodity would do well here.

Your thesis seems sound. The USA and many advanced societies need infrastructure. Steel looms big here, pun intended.

I guess I should hold for eking out a bit more?

[jorisderooij]

cheap for a reason. They offer stock at cyclical lows, and buy back at cyclical highs. They are okay at staying in business, but are horrible capital allocators. Buyer beware.

[barbarika]

Don't trust this management. The article does not mention the ~120million mandatorily convertible shares which negates the buyback. This conversion is coming due really soon. Selling the equity at dirt cheap prices a couple of years ago was a big scam they pulled on the shareholders with no justification for it at all. They will screw retail shareholders at the expense of their buddies/other deep pocketed investors... just as they did with this equity raise/dilution.

[The Investment Doctor]

@barbarika Care to elaborate on how the deep pocketed investors/buddies made money at the expense of the small shareholders?

[barbarika]

@The Investment Doctor the capital raise was only opened by the investment banks running the capital raise (& management) to bondholders with deep pockets, the average retail shareholder was not given a chance (zero notice) to take part in this (very favorable terms) capital raise.. I am sure you will find this if you go back look at the detail on that capital raise they did under the guise of the pandemic. The pandemic has been a good excuse for pulling all sorts of schemes, especially shady management like this is very open to pull these shady schemes. One of the analysts on a subsequent quarterly earnings call pointed out the quite unnecessary need to do this capital raise (offered to a select few and on very good terms to the bondholders but bad for retail shareholders leading to 20% dilution !!) and the response was very "ho hum" and secretive from the management on the call. So I can only conclude that the select few who got to partake on this were friends/family/select few known to the mgmt.

[The Investment Doctor]

@barbarika Isn't that a little bit 'hindsight 20/20'? At that point they were expecting a $0.5B EBITDA in Q2 and the EBITDA wouldn't even have been sufficient to cover the sustaining capex, and let's not even talk about interest expenses.

I don't think you can blame a company for wanting to raise cash when times are tough. The share offering was only for $750M at $9.27 on May 12th. The share price traded BELOW the $9.27 level for the SUBSEQUENT THREE DAYS, up to a low of $7.58 a few days AFTER announcing and pricing the capital raise. So you actually had the opportunity to buy stock about 15% BELOW the capital raise price (the closing price on May 13th, the day after the pricing, was less than $8).
So if you really wanted in and buy more stock at $9.27, you actually had plenty of opportunity to do so on the open market.

I'm sorry, but smaller shareholders had plenty of opportunity to buy stock at or below the level the big boys paid. Sounds like sour grapes to me.

[Undervalued_stocks]

Isn't CLF a higher return probability Vs MT?

[Green Candles]

Stock fell 75% from 1/1/18 to 3/1/20 and Covid was not the reason. That must have been memorable for shareholders. A 30% rally from here and we're back to breakeven. (after tripling off the bottom.)

I'll look at it in January. Folks who bought in last half of '21 are under water here. The numbers do seem compelling.

[marpy]

Is trading at 1.5 x EBITDA for a reason. - Other than for the Mittal family, Its not a very shareholder friendly company. Share buy backs?? Big deal as all its done since it announced its buy backs is go south. The market does not care about share buy backs that are not accompanied by appropriate dividend increases. It MT's case, the 30 cent a share dividend = peanuts.

[mmnelson3]

@marpy let me know if I’m thinking about this wrong, but doesn’t buying back shares also reduce the total expense from dividends then?

For example, if they end up buying back 40% of the shares by the end of next year, wouldn’t the total dividend payout be smaller as well?

In other words, if shares continue to be repurchased without a corresponding share price increase, the per share dividend stays the same but the total payout drops significantly.

Seems to me that the prudent strategy is to buy back shares until there’s share price appreciation at which point paying dividends becomes the more attractive option.

Obviously, I’m excluding investing in decarbonization and expansion as well as debt repayment but they aren’t neglecting either of those.

[The Investment Doctor]

@mmnelson3 You got it. Reducing the share count by 20% reduced the dividend payment (in dollars) by 20%.

[marpy]

@mmnelson3 Does not change the fact that, they are spending money on buy backs and so far it has put nothing in investors pockets as a result. With dividends, they are solid returns that investors can chose what to do with as in real money.

[worldly]

Great article. Would this in top 5 or 10 of your ideas? Your analysis is very good. Just want to judge where it fits in your scheme. TIA

[The Investment Doctor]

@worldly Unfortunately I can't buy everything. I used to own Arcelor, sold at roughly the current share price), but the tailwinds are stronger than I had anticipated (so in hindsight I never should have sold, so I was wrong there!).

The main issue is that we don't know when the tailwinds will become cyclical headwinds. And that will for sure happen, but thanks to the billions and billions of cash flow the balance sheet is now in a much, much better shape.

The only steelco i currently own is Algoma Steel. I have written some puts on CLF (which will all expire way out of the money), and I'm considering doing the same for ArcelorMittal (not sure if I'll pick the Amsterdam or NYSE listing yet).

[Jozsef]

I recently increased my position. Expect good returns going forward.