ArcelorMittal Hit Hard On Weakening Spreads And Evidence Of Demand Erosion

This has been a rough year for ArcelorMittal (NYSE:MT), as weakening demand and higher production costs have started to squeeze steel spreads more intensely. Macro concerns continue to dominate and overshadow the underlying operating improvements at this global steel giant, sending the shares down about 25% since the start of the year.

It’s hard for me to see significantly more downside in U.S. or EU steel prices from here, but commodity markets have a way of surprising in both the good and bad times, and even if prices stabilize near current levels, spreads are going to remain under pressure. As far as positive drivers go, I like ArcelorMittal’s opportunities in India and its focus on returns in mature markets, but those drivers likely won’t do much to offset the difficult macro environment.

ArcelorMittal shares look undervalued by all of the approaches I use, but sentiment on most segments of the steel sector is pretty poor now, and I don’t expect a particularly strong macro backdrop for 2023. This may be a name for more contrarian investors to consider as a longer-term rebound play, but it’ll take patience to work out.

 

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ArcelorMittal Hit Hard On Weakening Spreads And Evidence Of Demand Erosion

ArcelorMittal: Macro Risks Weigh Heavily On An Improved Story

 

I wasn’t sure I’d ever see a day where steel companies were getting praised as good stewards of capital, ArcelorMittal (MT) in particular, but I suppose given everything that’s happened in the world since 2019, this is further down the list of “things I didn’t think I’d see…” As is, management is doing an excellent job here, with an improved focus on quality over quantity and an eye toward ensuring that shareholders share in more of the upside.

While I do think that many steel stocks have overshot in the cyclical correction and that prices are likely to stabilize relatively soon in the U.S. and Europe, the reality is that sentiment remains a risk as margins are likely to slip further. What’s more, Russia’s invasion of Ukraine creates even more uncertainty for ArcelorMittal given the company’s significant operations in that country.

I was neutral on these shares (and the sector) back in September, and while ArcelorMittal hadn’t done any worse than the average steel stock since until the invasion of Ukraine, the sector has underperformed the broader market. These shares do look undervalued now, but I do also see more long-term risk to sentiment on post-peak margin declines and the situation in Ukraine.

Investors who can afford to be patient (as well as assume the risk of greater steel price corrections and a bad outcome in Ukraine) may well see outsized rewards, but I’m not eager to pursue the elevated risks here even though management is doing a commendable job.

 

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ArcelorMittal: Macro Risks Weigh Heavily On An Improved Story

Operational Leverage And Improved Clarity Have Catapulted ArcelorMittal Shares

Among commodity companies, weaker players typically outperform in up-cycles as they see even greater operating leverage benefits from higher prices and volumes. That would be enough to explain at least some of ArcelorMittal’s (MT) impressive performance since September, but added clarity on capital allocation priorities and operational strategies has analysts feeling quite a bit more confident about a sustained improvement in full-cycle profitability at this giant steelmaker.

I’m cautiously optimistic on the prospects for improved full-cycle profits, as management is both saying and doing the right things, and has taken some meaningful steps to improve returns and walk away from lower-return assets. Still, improvements to commodity company operating models aren’t really proven until the next down-cycle, and that’s clearly not the environment today.

I don’t find Arcelor shares to be particularly cheap today, but that’s in part due to my belief that steel prices are going to start declining in the second half of the year, shrinking the operating leverage for the sector in 2022. I can see upside to the low-to-mid-$30’s on a “stronger for longer” steel market (a more bullish scenario, in other words), but as is I think Arcelor is more or less priced in line with other quality names today.

 

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Operational Leverage And Improved Clarity Have Catapulted ArcelorMittal Shares

ArcelorMittal Shows Its Serious About Self-Improvement With The Sale Of Its U.S. Operations

ArcelorMittal (MT) management has been trying to convince the Street for some time that it is serious about changing how it operates – instead of trying to bigger, management is focusing far more on being better, with a much greater focus on long-term capital returns from assets. Most have been skeptical about this, including me, as there seems to be one oddly questionable decision made by management to offset every good decision.

With the Monday announcement of ArcelorMittal’s intent to sell its U.S. operations to Cleveland-Cliffs (CLF) in a cash and equity deal, I believe ArcelorMittal management has taken a very big step toward showing that it is serious. I believe the company is getting good value for suboptimal assets in a difficult market, and I like how it backs up the general idea that management is now more focused on the long-term capital returns of the business.

I was lukewarm on ArcelorMittal back in August, as I didn’t like the company’s position as a less-than-great player in a market that I believe is not going to see a lot of pricing strength. The shares have since lagged names I preferred more (including Steel Dynamics (STLD) and Ternium (TX)), but if the indicated pre-market pop holds up, that ArcelorMittal’s relative performance will have improved meaningfully. It still won’t be my preferred name, but it’s harder to stick with a bearish argument regarding management’s vision and discipline toward making this a better steel company for the long term.

 

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ArcelorMittal Shows Its Serious About Self-Improvement With The Sale Of Its U.S. Operations

ArcelorMittal's Low Valuation Offset By A Weak Price Outlook

One of the quirks of investing in commodity companies, and steel in particular, is that you typically want to own the inferior companies during the up-cycles. While pretty much every steel company saw share price improvement in the 2016-2018 upswing, names like ArcelorMittal (MT) and U.S. Steel (X) outperformed generally better-regarded names like Steel Dynamics (STLD) and Nucor (NUE) (though Steel Dynamics did quite well). Since the peak of steel prices, the script has flipped and ArclorMittal and U.S. Steel have noticeably lagged those other names.

I believe this second quarter will likely mark the bottom of the cycle for shipments, but I believe pricing could be lower for longer, which complicates positioning for the cycle. Lower-quality companies tend to do better when steel prices bottom and rebound, and that may not happen for several years. Consequently, while ArcelorMittal shares do seem to be trading at a very low valuation, even in the face of deteriorating near-term results, the uncertain timing of a sustained rebound in steel prices makes this a tougher call.

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ArcelorMittal's Low Valuation Offset By A Weak Price Outlook

ArcelorMittal Up Nicely Off The Bottom, But Substantial Uncertainties Remain

Valuations looked pretty washed out across the steel sector going into third quarter earnings, and my last article on ArcelorMittal (MT) was titled “ArcelorMittal Likely Approaching The Bottom”. Since then, the shares are up more than a third on renewed optimism that steel prices have bottomed, that margins likewise have bottomed, and that the company may walk away from its questionable decision to take over Italy’s Ilva.

What is ultimately going to happen with Ilva is anybody’s guess; ArcelorMittal has offered the Italian government a path toward a resolution, but sound decision-making may be too much to expect. I do still believe these shares are undervalued, but with the market arguably now leaning too positive toward the steel market, I’m not inclined to push my luck here.

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ArcelorMittal Up Nicely Off The Bottom, But Substantial Uncertainties Remain

ArcelorMittal Likely Approaching The Bottom

It’s been a pretty brutal year for steel stocks, as even protectionist policies in the U.S. and EU haven’t done much to shore up weaker pricing and demand. I’ve been pretty negative on most of these stocks, though my basic thesis of “own good names like Steel Dynamics (STLD) and Nucor (NUE) if you have to own something” has played out, as those two companies have done less worse than ArcelorMittal (MT) thus far this year.

The flip side of owning better companies in tougher times is considering worse companies when conditions start to bottom out. Although I expect ArcelorMittal to report a pretty ugly third quarter, and I don’t think the fourth quarter will be all that much better, I think ArcelorMittal’s business may be bottoming out now. To that end, I believe this global steel giant could see double-digit EBITDA growth in 2019 and solid single-digit growth in 2020 and 2021, although the risk of recession in both North America and Europe is still a significant risk factor.

I don’t have enough confidence in ArcelorMittal to call this a must-buy, but I like the company’s asset sale plans (vague as they are), the ongoing emphasize on price and margin over volume, and the potential uplift from improvements at newly-acquired Ilva. At this point, I believe ArcelorMittal shares should trade closer to $20, and this is a name for more aggressive contrarians to consider.

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ArcelorMittal Likely Approaching The Bottom

Ternium Beaten Up, But The Quality Is Still There

The six months since my last article on Ternium (TX) have not been kind to the steel sector in general, nor this Mexican steelmaker in particular, with the shares down about 16% and roughly doubling the decline of the sector. While the sector has been pressured by weaker prices, rising costs, and concerns about demand growth in 2019 and beyond, Ternium too has been squeezed by pricing and costs, not to mention weaker-than-expected demand in its key operating regions.

Macro factors remain my biggest worry with Ternium, as construction activity has yet to turn in Mexico and Argentina’s “recovery” is at best looking like a drawn-out process. Improving demand in Brazil should help, but global weakness in the auto industry remains a point of pressure for the company. Given Ternium’s excellent margins (even in comparison to leaders like Nucor (NUE) and Steel Dynamics (STLD) ), longer-term prospects in both Mexico and Brazil, and the valuation, this is still a name I like within the steel sector.

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Ternium Beaten Up, But The Quality Is Still There

Gerdau's Share Price Weakness May Not Be Entirely Reasonable

I was skittish about the near-term performance prospects for Gerdau (GGB) back in early December, and the shares have fallen about 10% since then – modestly underperforming a weak steel sector over that time. Gerdau’s share price performance hasn’t been helped by weaker steel prices in the U.S., nor a slower-to-develop recovery in Brazil, and costs continue to rise in the meantime.

I’m not all that bullish on the U.S. steel sector, but I think Gerdau has significantly upgraded their U.S. operations, and I’m more bullish on the prospects for Brazil’s steel sector over the next few years as the country makes a tentative economic recovery. Like Ternium (TX), I think Gerdau could be positioned to post EBITDA and FCF growth at a time when U.S. steelmakers will have more lackluster results, and a stronger recovery in Brazil could maintain investor enthusiasm for that region. I’m less bullish on Gerdau relative to the sell-side, but below $4/share, I think these shares are worth a look.

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Gerdau's Share Price Weakness May Not Be Entirely Reasonable

Steel Dynamics Has Near-Term Challenges, But The Valuation Is Getting Interesting

I was “cautious” on Steel Dynamics (STLD) back in January due to the challenges that come with descending from a cyclical peak, but it has still been among my favorite steel names for some time. To that end, I’m a little surprised that it has underperformed the sector since that last article, though another of my preferred names, Ternium (TX), has done even worse, while Nucor (NUE) has done a little better. On the other hand, a quick look at AK Steel (AKS), ArcelorMittal (MT), Gerdau (GGB), or U.S. Steel (X) and you realize it could still be worse.

I still believe this is a very well-run steel company, but I’m also still concerned about the underlying health of the U.S. short-cycle economy, the prospect of weaker demand and prices, and higher conversions costs. If that weren’t enough, there’s also the matter of meaningful U.S. capacity additions in sheet steel over the next few years. I do believe that Steel Dynamics is undervalued and might have some longer-term appeal now (particularly for investors with a more bullish outlook on the U.S. economy), but I do think Nucor has the better product mix for the next 6 to 18 months.

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Steel Dynamics Has Near-Term Challenges, But The Valuation Is Getting Interesting

ArcelorMittal Lagging On Weaker Markets And Margins

Steel hasn’t been a particularly popular sector over the past three months, with the sector down about 7% or so. Unimpressive as that is, it’s downright aspirational for ArcelorMittal (MT), which has seen its share price drop about 20% over that time, with a significant drop in just the last two weeks. Between uninspiring prices in most of its markets, higher costs, and concerning macro signs, there are plenty of contributing factors to consider.

I’ve said it before and it merits repeating – stocks don’t go up just because they’re cheap. It usually takes some other catalyst, some reason to believe that the tide is going to turn in a more positive direction, to get share prices moving, and that could be problematic for ArcelorMittal in the near term. While I believe management is running the business along generally sound lines, weakness in Europe and emerging concerns about the U.S. market are likely to stick around a bit longer and ArcelorMittal really needs some beat-and-raise quarters coupled with a stronger steel market to change sentiment.

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ArcelorMittal Lagging On Weaker Markets And Margins

Nucor Has The Right Mix And A Better Valuation

I wasn’t a big fan of Nucor (NUE) back in February, and I don’t feel like I’ve missed out on anything with the 10% move down since then. While Nucor remains one of the best operators in the steel business, prices have weakened as I expected and volume hasn’t made up the difference. What’s worse, costs are rising and I think companies in the steel sector may be counting on more volume/demand recovery in the U.S. than the economy can support.

With the downward move the shares are more interesting now. I still prefer Steel Dynamics (STLD) and Ternium (TX) (though the shares of the latter have been quite weak since February), but Nucor does seem to offer some upside on my EV/EBITDA valuation approach, and Nucor should benefit from oncoming volume/capacity increases in a still-healthy market while others are now investing for capacity that won’t come into play for years.

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Nucor Has The Right Mix And A Better Valuation

Nucor Has The Right Mix, But Will The Market Cooperate?

I continue to prefer Steel Dynamics (STLD) among U.S. steelmakers, but Nucor (NUE) has been the better performer over the past year (they're tied over the last two years, and STLD wins the five-yr comp), and the shares are up about 15% since the Christmas Eve 52-week low on renewed enthusiasm over better steel demand and pricing in 2019. I do like Nucor's comparatively stronger leverage to long products and plate (where I think prices will be noticeably better in 2019 relative to hot-rolled coil), but I think investors will need to wait until 2021/22 to see year-over-year growth in EBITDA again (on a full-year basis), and I see more that can go wrong with pricing and demand at this point than what can go right.

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Nucor Has The Right Mix, But Will The Market Cooperate?

Gerdau Looking Toward Better Results

Brazil’s Gerdau (GGB) offers a curious investment proposition today. Although the shares have lagged Ternium (TX) over the past three months, Gerdau has been the best-performing steel stock of the group I follow closely, and by a fairly wide margin (outperforming #2 Ternium by close to 15%). Gerdau is also one of the few steel companies/stocks where there is basically a unanimous expectation of EBITDA heading higher for the next two to three years, largely on the back of an expected recovery in Brazil.

Metal spreads may well have peaked in the U.S. (where Gerdau generates close to a third of its EBITDA), but volume demand growth is expected to continue and Gerdau has under-utilized capacity it can bring into action. What’s more, spreads in Brazil could still improve and Gerdau is still reaping the cost savings benefits of digital investments. Gerdau’s valuation doesn’t scream “bargain”, but in the real world of stock performance, this is still a name to consider given its potential for further upward earnings revisions and its capacity to grow at a time when many peers will see earnings contraction.

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Gerdau Looking Toward Better Results

POSCO's Share Price Seems To Be Predicting A Lot Of Doom And Gloom

Add POSCO (PKX) to the list of steel stocks with a confounding valuation, as investors seem to be pricing in a dire future that doesn’t seem fully justified by the financials. The trouble with cheap-looking valuations in commodity stocks is that you can be generally right about a “it won’t be that bad” thesis, and still see significant near-term declines as investors bail out of the sector on weaker prices and spreads.

POSCO shares look exceptionally undervalued now, so much so that I really have to second-guess what I’m missing in my modeling and analysis. While POSCO’s exposure to a weakening auto industry is a worry, as is the company’s new capex-heavy strategic plan, the market seems to be pricing in a pretty dire future for what I believe is at least a decently-run global steel major.

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POSCO's Share Price Seems To Be Predicting A Lot Of Doom And Gloom

ArcelorMittal Has Continued To Skid On Cycle And Capital Allocation Worries

Some of the best spreads in recent memory haven’t been much help to the steel sector over the past year, and now it looks like the cycle is meaningfully slowing down. With steel prices declining around the globe, apparent demand softening, and growing worries about expanding capacity, coupled with shrinking spreads and sell-side forecasts for declining EBITDA, it doesn’t look like a particularly healthy set-up for ArcelorMittal (MT).

I wasn’t bullish on ArcelorMittal back in September, even though the shares “looked cheap” by multiple metrics, and the shares have fallen nearly another 30% since then. I still can’t really bring myself to want to own these shares myself, even though once again the valuation seems harsh by most metrics I can evaluate.

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ArcelorMittal Has Continued To Skid On Cycle And Capital Allocation Worries

Wall Street Believes Winter Is Coming For Steel Dynamics

Metal spreads have continued to improve, but steel prices in the U.S. have come off their highs and analysts are now modeling 2018 as the peak year for Steel Dynamics’ (STLD) EBTIDA for this cycle. Fading prices and fading EBITDA expectations are never a good combo for commodity companies, and although these shares have outperformed peers on a one-year and year-to-date basis, the performance in recent months has been lackluster.

I do believe that Steel Dynamics is undervalued now and I do believe this is a relatively better place to be in the steel sector, but this looks more and more like a difficult place to make money for at least the next few quarters. Protectionist measures and a healthy economy may support a “stronger for longer” steel cycle, but I think it will be hard for these shares to significantly outperformance unless pricing and/or volumes really surprise.

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Wall Street Believes Winter Is Coming For Steel Dynamics

Nucor's Healthy Spreads Aren't Enough As The Cycle Moves Past The Peak

It’s often difficult to make money in commodity sectors when the cycle has reached and passed its peak, and that seems to be holding true for steel. Although spreads continue to improve and earnings expectations for Nucor (NUE) have continued to rise for both 2018 and 2019, the shares really haven’t gone anywhere this year as investors expect meaningful earnings erosion from here and move onto to greener pastures.

I believe it’s better to be in mini-mill and/or specialty steel companies at this point, but I’m still mostly lukewarm on Nucor. I do see some risk of overspending on M&A, as well as some vulnerability to increasing capacity, though I will emphasize again that this is a very well-run company in the sector. I continue to believe that fair value is above $70 per share, but this may be a tough place to make money unless/until there’s a reason to believe this cycle will persist beyond current expectations.

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Nucor's Healthy Spreads Aren't Enough As The Cycle Moves Past The Peak

Can A Better Second Half Drive Some Enthusiasm For ArcelorMittal?

My concerns back in the late spring about it being too late in the cycle to make good returns in steel sector appear to have played out this summer. ArcelorMittal (MT) has declined more than 10% since my last update on the company, despite a stronger-than-expected second quarter and a stronger outlook for the second half. What's more, steel prices have held up, as has demand, and spreads are still attractive. It's not just ArcelorMittal, though, as Voestalpine (OTCPK:VLPNY), U.S. Steel (X), Ternium (TX), Steel Dynamics (STLD), and Nucor (NUE) are down over that period as well, and Acerinox (OTCPK:ANIOY) is barely up.

ArcelorMittal looks very cheap on the basis of near-term EBITDA, and even looking a few years ahead to declining prices and profits suggests that today's valuation is weak relative to historical norms. At this point, I'm not really sure what's going to bring investors back to this name, as steel prices aren't likely to improve much (if at all) from here, and investors tend to bail when pricing momentum fades. So, while I do think ArcelorMittal looks unfairly cheap, the markets don't care about fair, and investors considering these shares need to be aware of the risk that this is a value trap.

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Can A Better Second Half Drive Some Enthusiasm For ArcelorMittal?

Ternium Continues To Surpass Expectations And Still Seems Too Cheap

Ternium (TX) confounds me at times. This Mexico-focused steelmaker has an above-average track record when it comes to margins and returns on capital, operates in a pretty stable region, has access to multiple growth markets, and has been investing in growth projects at what appear to be good future IRRs. And yet, Ternium trades at one of the lowest forward multiples in the group even after a good run in the share price.

As Ternium continues to beat and raise, my expectations go up as well. I do see some risk that EBITDA could reach a near-term peak in 2019 or 2020, but the company’s leverage to recoveries in Argentina and Brazil makes that a tough call, and there are still significant opportunities to gain share in its home market. Even at 4x my new 2018 EBITDA estimate, it looks like there’s double-digit upside left in these shares.

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Ternium Continues To Surpass Expectations And Still Seems Too Cheap