ArcelorMittal is the result of a merger between Arcelor and Mittal steel and is presently the largest steel-producing company in the world. It has industrial presence in Europe, Asia, Africa, North America and South America. It is also looking to position itself in the high growth Chinese and Indian markets.
Ticker Symbol: MT (NYSE)
Current Price: $16.05 (cap 24b)
Periods analyzed: 2001 to 2010
Date started: 10 Sep 2011
Date finished: 29 Sep 2011
The following are the words from the ArcelorMittal website and they support the claim by several examples. As I cannot check it myself, I trust their word.
“ArcelorMittal's core philosophy is to produce Safe, Sustainable, Steel. Safety is the Company's top priority. ArcelorMittal embarked on its Journey to Zero safety improvement process in 2008, striving to be the world's safest steel company. Progressive reductions in injury rates were subsequently achieved.”
The difference between a good business and a great business is in one word “moat.” When purchasing a business the famed investor Warren Buffett pays careful attention to a business’ “enduring competitive advantages.” This in a nutshell allows a company with a wide moat to produce above-average returns over long periods of time. It is the perfect recipe for a long-term investment.
For ArcelorMittal the moat is its massive size. It has a size and scale that dwarfs the likes of Posco, Salzgitter, Nucor and Ternium. While size can mean that the company is simply big (a set of businesses lumped together), achieving lower returns (because of its massive size, growth is hard to come), is unwieldy and hence has difficulty in changing with time. But it also means that the company has more efficient productions, has the upper hand in negotiating with the distributors and suppliers, and can offer a more reliable supply line to the customers. After analysing the company I put MT in the second group and in the rest of the article I hope to convince the readers that this indeed is true.
ArcelorMittal is a one stop shop for anything to do with steel. Their products can be categorized in the following broad segments
i) Automative: Covers the full range of metallurgical families, coatings and surface treatments of automobiles.
ii) Flat: Slabs, hot rolled, cold rolled, galvanized, plate, you name it, they have it.
iii) Long: Used in railways, sheet piling, construction.
iv) Mining: It is also amongst the top 5 producers of iron ore and metallurgical coal in the word.
v) Pipes and tubes: Customers are in energy, mechanical and automative markets.
vi) Others: Offers door-to-door logistics, copper foils for electronic industry and design and supply of complete plants through its 600 patented inventions.
2.5 Management and Insider Holding
Lakshmi Mittal who started his career working in his family’s steel business, is the architect behind Mittal steel. He built Mittal steel from a single plant in Indonesia to a 600-pound gorilla through a series of mergers and acquisitions. This acquisition reached its pinnacle in 2006 when he merged Mittal with Arcelor, creating the company ArcelorMittal. ArcelorMittal is his life’s achievement and work.
Insider ownership is a big selling point for an investment. Investors sleep well when they know that the management’s interests are aligned to their own. It is a meaningful show of confidence in the business. When the management has a substantial amount of their own capital at risk, you know that they will do whatever they can to make the share price goes up. For a huge business like ArcelorMittal, it is hard to find an executive with a substantial stake in the company. The only examples I can think of are Larry Ellison, an owner of 22% of Oracle and Larry Page and Sergey Brin, each having an 8% ownership in Google. The ownership of Lakshmi Mittal again dwarfs them in comparison — he owns more than 41% of the company.
3 Balance sheet
With the world economy collapsing around us (or so it seems) one wants a company with a rock solid balance sheet. This means low or manageable levels of debt. Let's look at ArcelorMittal’s balance sheet.
|Cash||5,919 m||6,207 m|
|Current Assets||32.8 b||42.67 b|
|Current Liabilities||23.5 b||30.72 b|
|Working capital||9 b||12 b|
|Long term debt||20.67 b||19.29 b|
|Debt/Equity||66 b/61 b||68 b/62 b|
As we see here, MT has improved on almost all metrics, even though the economy is going into a tailspin. The most interesting thing to see here is that the company has a working capital of $12 billion and a market cap of $24 billion. This number is a favorite measure of value at Ben Graham’s firm. It is good to know that the company is not selling at outrageous multiples of this measure. I will have more to say about the value of MT later on in the article, when we do the industry comparison.
The balance sheet does not give us a reason to be worried about the company.
4 Key business indicators and risks
4.1 Return on invested capital
The key, some say, to Buffet’s buying is a metric called return on invested capital. It is arguable whether ROE, ROA or ROIC are better indicators, which I will leave for other people to decide. In essence, ROIC takes into account both the equity put in by the investors and the debt the company has taken. If the company has taken significant debt compared to the equity, then the return will be much higher in terms of ROE but it will be smaller in terms of ROIC. It stands to reason that to look at how profitable a business is, one would look at the return it gives on total investment in it (including the debt). If the ROIC is high, time and compounding are the friend of a long-term investor.
Let us look at the ROIC and ROA of MT during the last decade.
|Return on Assets %||-5.53||0.91||1.18||37.93||13.41||7.30||8.44||7.05||0.09||2.26||2.50|
|Return on Invested Capital %||-10.20||1.91||2.73||91.71||25.60||11.92||13.15||10.58||0.13||3.35||3.72|
It seems that MT has performed quite admirably. The average ROIC for the last decade has been 15%, which is not too shabby.
4.2 Risk analysis
4.2.1 Cash risk
Due to the volatility of a cyclical business, it is essential to maintain a strong liquidity position for a company like ArcelorMittal. Since the crisis of 2008, MT has paid down its debt by over $10 billion ($26.5 billion in 2008 to $19.7 billion in 2010) and has restructured the remaining debt to reduce its exposure to bank borrowing. At the end of 2010 the cash and unused credit facilities amounted to $17.6 billion. In terms of liquidity, I see MT in a very comfortable position at the moment.
4.2.2 Another recession
The risk of another recession is quite an extreme scenario, I agree. But let us look at the situation anyway.
The selling and general expense of the company is around $5 billion since 2005. If the sales drop 25% to $58.5 billion (this is quite drastic for such a big company) and the net margin shrinks to 1% (at the moment it stands at 3.2%, which is quite low compared to historical averages), the company will make an operating profit of $0.5 billion and a net loss of $4.5 billion. With a $9 billion cash cushion, MT will ride it out, for the moment.
Being a company in a cyclical industry, it is expected that its profit/sales will fluctuate with the booms and busts of the economy and the industry. With the economy going downhill it is not surprising that MT has seen its net margin (NM) shrink to 3.62% and the return of the invested capital (ROIC) to 3.35%. However, if we look the data from the last five years, the NM averages at 6.5% and ROIC at 10.5%.
5.1 Historical valuation
If we look at the last 10 years, the company has performed admirably and has done a very good job managing itself through the cycles and still maintain profitability. In the past decade, only in 2001 the company has shown a net loss for the full year.
Let us look at the valuation history of the company in terms of the P/S, P/E and P/B.
Data taken from Morningstar
As we see here, MT is selling at a multi-year low on almost all metrics. The P/B value is lowest in the decade, and the P/S is also lowest since 2004. On top of that the company is arguably at a better position and bigger since 2001.
5.2 Competitor comparison
We now pit MT against its competitors across the globe. Here I am looking at Nucor (NUE), Salzgitter (SZG), and Ternium (TX). I will give a series of tables comparing them on balance sheet, frequently used ratios, and profitability.
|Book value (‘01)||Book value (‘10)||Current ratio|
|Company||NM||Exec pay (% profit)||ROIC|
|MT||3.74%||2.4 m (1%)||3.35%|
|NUE||0.85%||16.48 m (> 10%)||1.23%|
Let us take each competitor and see why they offer less compelling opportunity than MT.
Salzgitter is a metal producer in Germany. Germany is the dominant economy in the euro zone and has been performing comparatively well during the recession. The economy has bounced back nicely and the employment is down. In this environment Salzgitter has additional benefit of low euro price (which transforms to low cost and high profit margins).
In the first table we see that Salzgitter is quite undervalued with P/S of 0.2 and PEG of 0.1 (recovering sales). The P/CF is negative and worrying. If we look at the cash flow statement then we see that Salzgitter’s FCF is negative for the last year ($237 million) and the TTM FCF is also negative by $439 million. I would wait for it to stop losing money before investing. Salzgitter’s dividend has gone down from €3 (2007) to €0.25 (2009) and is now going up to €0.32 (2010).
If we look at the the second table we see that Salzgitter’s five-year growth rate is quite abysmal at 3%. Even the 10-year growth rate is only 9%. Furthermore, the margins have suffered terribly and have gone down from a peak of 17.85% in 2006 to an abysmal 0.36% in 2010.
The bottom line is it seems that Salzgitter is quite undervalued at the moment, if one assumes that it will recover. And I am very sure it will. But the time for it to recover can be substantial. The company has been going downhill since 2006 and has in the last 12 months shown a sign of recovering on almost all fronts. The sales, dividend, margins have all improved even if by a small amount. Frankly, I would apply a wait-and-see approach here.
Nucor is one of the largest steel producers in U.S. The state of the U.S. economy is not hidden from anyone. So, let us jump right back to the numbers.
Comparing it to the rest of the companies, Nucor has the largest P/S, P/B, and P/E but has the best P/CF. Also, Nucor has been taking on debt which has gone from $3 billion in 2009 to $4.3 billion in 2010. The 5-year growth rate averages at 4.5% and in the last 10 years the book value has tripled. If we compare it to MT, which has increased its book value almost 13 times in the same duration, has more reasonably paid executives and frankly has a better management, the choice becomes clear.
Ternium is a long steel manufacturer in Mexico, Argentina, Guatemala, Colombia and the U.S. The company was formed in 2005 and since then has tripled its book value. It has access to the high-growth emerging markets and has performed admirably on all counts.
Comparing it to MT in table 1, it makes MT look cheaper again under each of the columns. MT has better P/S, P/B, P/CF and dividend yield.
It is amazing that ArcelorMittal, which is so large and has managed to grow so much can still trade for such a low valuation at the current moment. We now look at some models to establish the price of ArcelorMittal.
I would like to discuss here some of the key metrics and the stock price and try to estimate the correct value of the underlying company.
5.3 Price-to-sales ratio
Sales are what drive business; everything else is the result. Earnings, cash flow, expenses, dividends, all come later. So it stand to reason that we look at the sales more carefully.
In the last five years since 2005, MT’s sales have peaked at $125 billion in 2008 and now stand at $78 billion. This is nothing out of order as the economy of the world has gone into tailspin. The industry as a whole has also gone down by more or less the same amount. The sales of steel as a whole were hurt by 60% in 2008 and MT was hurt around 66%.
The current P/S ratio of MT stands at 0.3. Over the last decade MT has sold between a P/E of 19.6 (2009) and 5.3 (2004). Meanwhile, the net margin has been between 1% in 2002 and 21.18% in 2004. Assuming that MT can maintain a net margin of 8% and the market is willing to pay a P/E of 10, with no growth, the company is worth:
P=Sales*P/E*Net Margin= $62 billion
Which is nearly 2.5x the current market cap. As one can see, this is a very conservative estimate (no sales growth, 8% margin and 10 P/E).
5.4 Discounted Cash Flow Analysis
The EPS stands at $2.07. The 10-year average EPS growth rate is 7.69%. The current price of $15.73 a share of MT assumes a 5% growth rate for five years, stable growth rate of 1% afterwards and a 16% discount.
This is as one agrees, quite a bleak analysis given the performance of MT in the past decade. If one assumes a more realistic scenario of 6% growth for 10 years and 1% growth afterwards (half the growth rate of inflation adjusted GDP), and a 10% discount to S&P, the shares are worth $28 a share.
Why should you buy MT? The answer is, because it is so unbelievably cheap. It is selling at a multi-year low even when the sales and margins are recovering and the company is paying down the debt. You can also rest knowing that the person responsible for the company has built it from scratch and holds 41% of the ownership stake. He has not sold any shares for a long time and this shows his commitment to the company. And this is not “some” company, far from it. It has a presence all across the globe and continues to acquire more companies. The company has seen many tumultuous years since its inception in 1980s and I will bet that the current situation is not much different. I believe in the capable CEO and hence will be buying more on dips.
7 Additional disclosure
a) I am long on MT and TX. I bought them on recent pullback. I have around $500 in TX and $180 in MT.
b) Most of the data has been taken from morningstar.com and the respective financial reports of the companies.
About the author:I started investing in December 2009
and my first stock CreditSuisse (CS) tanked to almost half its
value. This nudged me to start learning about investing from the ground
up. I am a long term value investor and am planning to generate sustainable amount of money from investment income by the time I am 40 years old i.e., 2025.