Using EBITDA Multiples To Compare Steel Companies

Includes: AKS, MT, NUE, STLD, X
by: Bennington Investment Ideas

Fundamental investors look at valuation metrics in hopes of finding solid investment opportunities. These metrics range from P/E ratios to cash flow multiples to EBITDA multiples. Each has its own advantages and disadvantages. This article will look more closely at EBITDA multiples for the steel industry, with a focus on U.S. Steel Corp (NYSE:X). The following companies will be considered:

Select Steel Companies
Ticker Name Market Capitalization ($ B) Recent Price ($ per share) Dividend Yield
MT ArcelorMittal 23.9 15.44 4.1%
NUE Nucor Corporation 12.8 40.22 3.6%
X United States Steel Corporation 3.1 21.15 0.9%
STLD Steel Dynamics, Inc. 2.8 12.78 3.1%
AKS AK Steel Holding Corporation 0.6 5.19 3.9%

Source: Yahoo!Finance for all data, including forward dividend estimate used to calculate forward dividend yield.

The first observation is that most of these companies, except for X, pay a pretty attractive dividend, especially when one considers that the S&P 500 typically pays around 2%. X has really struggled on the dividend front, having cut its quarterly dividend during the Great Recession to the current level of just five cents each quarter. NUE also cut is dividend at the same time, but by a substantially smaller amount. Furthermore, it has made two small increases to the quarterly payment.

Understanding EBITDA

EBITDA (or earnings before interest, taxes, depreciation and amortization) is a common proxy for a firm's financial earning power. The following table shows the 2011 and 2010 EBITDAs for these five companies:

EBITDAs for Steel Companies ($ millions)
Ticker EBITDA 2011 EBITDA 2010 EBITDA 2009
MT 10,187 8,451 3,160
NUE 1,852 882 235
X 869 389 (913)
STLD 824 609 344
AKS (7) 72 156
Source: Yahoo!Finance for EBIT and Depreciation

This table shows that, with the exception of AKS, these steel companies are still recovering from the downturn. One of the challenges in using EBITDA is that it ignores the capital cost of generating revenues and profits by excluding depreciation. Even though depreciation was pretty consistent for each company over the past three years. Some would argue that this is less of an issue since depreciation is a non cash expense. This would mean possibly that EBITDA is closer to cash flow. However, this excludes the need for capital expenditures. If anything, since the depreciation is based on historical costs, it overstates EBITDA as a proxy for cash flow. For example, in 2011, X had $681 million in depreciation, but $848 million in capital expenditures.

EBITDA is also subject to the machinations that go into the formulation of an income statement. EBITDA is before taxes and interest and so different tax situations of companies is also excluded.

EBITDA Multiples
Ticker MC ($B) EV ($B) MC/2011 EBITDA EV/2011 EBITDA
MT 23.9 46.0 2.3 4.5
NUE 12.8 15.0 6.9 8.1
X 3.1 6.3 3.5 7.2
STLD 2.8 4.7 3.4 5.7
AKS 0.6 1.9 (92.3) (295.4)
Source: Yahoo!Finance for MC (market capitalization) and EV (enterprise value) and author calculations

This table shows another key point on using EBITDA multiples. EBITDA multiples should be used with care when comparing across market capitalizations. This is because EBITDA excludes the impact of interest. EBITDA is what is available to satisfy three sets of stakeholders: Debt in the form of interest, government in the form of taxes, and equity holders in the form of net income for potential dividends. One could argue that this cash is also necessary for the company itself in the form of capital expenditures.

This issue can be seen in that X has a relatively low EBITDA multiple on MC, but when looking at the EV/EBITDA multiple it is much less attractive. MT also shows a substantial increase as well. However, NUE appears to be quite unattractive from a MC/EBITDA perspective, but looks relatively better on the EV/EBITDA basis due to its low leverage. As noted before, I believe you can only look at the EV multiple.

The next key aspect is about multiples in general. In addition to making comparisons between companies, it is important to account for different rates of growth and costs of capital. In the same way that higher growth can justify a higher P/E ratio, that same higher growth can help support a higher EBITDA multiple. Hence STLD and MT with lower 2010-2011 growth might explain their lower multiples. (This assumes that the recent growth is indicative of future prospects). In contrast, both X and NUE have shown much more robust recoveries and perhaps have better prospects, justifying their higher multiples. In contrast, AKS is headed in the wrong direction.

Looking further at X and more recent growth shows that H1 2012 EBITDA is down slightly from H1 2011 EBITDA with $507 million to $533 million based on SEC filings. This suggests that X might have rebounded from 2009 nicely, but is not struggling to find growth in today's market uncertainty. Another point of concern on X is that while $848 million went to capital expenditures in 2011, just $29 million went to shareholders in the form of dividends. This ratio is just 3% (dividends to capex) to show the order magnitude difference. In contrast, this same ratio for NUE would be about 119%, quite a difference.

This analysis shows the importance of understanding EBITDA multiples. Furthermore, with a relatively high multiple and flat growth, X might now not be a great investment right now. However, additional research and investment should be done prior to making any investment decision.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any 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.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

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