Okay, but we’re value investors, right? We want to buy at a deep discount what is worth two, three, five times our investment. Is this the case?
Before delving into numbers, let’s talk briefly about MT's history.
From India to Everywhere
Lakshmi Mittal, its Indian founder, started his steel business in 1976, with a company named Mittal Steel. During the following years, the company had a spectacular growth, and in June 2006 it acquired Arcelor SA, in forming “steel titan,” with around 10% of the global market share.
I think the best description of Mr. Mittal’s wonderful journey in the steel world is the one that Mohnish Pabrai provides in his The Dhandho Investor, which I highly recommend to everyone who wants to deepen his knowledge (and also have a different point of view) of the value concepts applied by Buffett, Gates, Greenblatt, and…. Mittal!
Here’s a little excerpt from that book that gives you an idea of how difficult what Mr. Mittal has done is:
“What is amazing about Lakshmi Mittal’s Dhandho journey is that he invested all his energies and tiny capital base in an industry with terrible economics-steel mills. Unlike Microsoft, in a steel mill you have no control over the selling price of the finished product and you have no control over the cost of raw materials.”
“Mittal started in 1976 with a single, small, nondescript steel mill in Indonesia. Despite having all the odds stacked against him, he ended up creating one of the largest and most profitable steel businesses on the planet.”
ArcelorMittal Mining business
MT organizes its business through several divisions. They are: Flat Carbon Americas; Flat Carbon Europe, Long Carbon Americas and Europe; Asia, Africa and Commonwealth of Independent States (CIS) (AACIS), Distribution Solutions and Mining.
The pure steel divisions have been steady in terms of their operations for years. Although there’s a continuous effort in reducing costs by running efficient steel mills (and there’s nobody better than Mr. Mittal in doing it) and producing the best-quality steel, there’s nothing you can do against the structurally cyclical demand of steel products in the world.
As we’ve just told, companies like MT make big profits when the economy is on the rise and there’s a huge demand for steel (for example, coming from the “Detroit big three” and German car makers), and usually experience losses when they’re in the midst of a recession.
We’ve also seen that one of the greatest challenges of a steel company is the fact that they generally have no control over the cost of raw materials.
Also if they’re able to hedge against raw material rise (or speculation), if price swings are really big, they could end up being unprofitable also if volumes are very high.
Mr. Mittal has really taken to heart this issue and has spent the last several years running the company trying to solve it. And I think he has almost succeeded in doing it.
The idea is simple: Why don’t we extract by ourselves the raw materials we need in order to produce steel?
The iron ore mineral represents the main ingredient (and cost) in the steel producing process.
The problem is, most iron ore mines are already owned by the “big three” of the mining world: BHP, Vale and Rio Tinto, accounting for almost 70% of the (known) total reserves.
They usually set a price in a closed-door negotiation with steelmakers for the price/tonne level and everyone in the world accepted that price as the reference for a whole year.
In recent years this system has begun to change, with participants in demand and supply chains initiating a shift to short-term pricing (of course China has a big role in this affair; if you want to delve into it, you can click here).
So basically, what ArcelorMittal has done is try to acquire some of the remaining (or newly discovered) iron ore mines all around the world.
In particular, Mr. Mittal has been mostly interested in the mines with the best asset values (in terms of volumes and mineral quality), but that, for one reason or another, he could buy for way less than their real value (sounds familiar).
Reasons could be a distressed situation of the owner or some big investments needed to begin extracting the mineral in an effective way.
One example is given by ArcelorMittal’s recent acquisition (together with Nunavut) of the Canadian Baffinland Iron Mines Corporations, owner of a huge iron ore deposit, but that was idled for a long time because of the big investments needed to reach the mineral in a very inhospitable environment.
MT is growing its iron ore production year by year (it increased its production by more than 10% in the last year), and most of its shipments, of course, are internal, going to feed its own steel mills.
This significantly reduces the impact deriving from a rise in iron ore prices (in 10 years, the price has grown up to 10 times compared with the 2002 level, with the current price being around $140 per tonne), so I think Mr. Mittal has brilliantly solved one of his two bigger issues. In fact, his company has now some (strong) control on prices of raw materials needed to produce steel!
Latest quarter results
On May 10, 2012, ArcelorMittal reported its first quarter 2012 results. They were not so exciting, but the company managed to come back to profitability, after a red fourth quarter.
Revenues were slightly better than first quarter 2011, but margins were impacted by steel selling prices. There were improvements in the automotive segment (particularly in the states), with the Europe business struggling as European governments (and companies) trying to delay big investments to better times.
What I think is really interesting here can be observed when comparing revenues and EBITDA figures:
Flat Carbon Americas
Flat Carbon Europe
Long Carbon Americas and Europe
Asia Africa and CIS
Here’s why Mr. Mittal has almost completely focused on mining: Even if the segment accounts for only 5% of revenues, it represents a stunning 25% of total EBITDA.
If the mineral is shipped internally (figuring as revenues for the mining segment and as a cost for the steel divisions) or externally (sold at current market prices), the result is the same: producing (and selling) iron ore improves margins.
This is exactly what a steel company needs in a recessionary environment. MT is not only avoiding to suffer too much from raw materials price rises, but is also succeeding in making a profit on it.
ArcelorMittal is led by one of the best businessmen in circulation. The company possesses big amounts of natural resources (basically iron ore mines) that can balance the mix when times are not good for the steel segment.
The management is very conservative: For example, the debt/equity ratio has been less than 0.5 for many years. Dividend yield is around 5% and (tangible) P/B ratio is around 0.5, so at these prices you could buy all this stuff for half its value.
Mr. Mittal's net worth is around $20 billion, starting from almost nothing 30 years ago. I think we’ll hear a lot about him at the top of the next cycle.
In the meanwhile, if you want someone like him to manage a part of your assets, you could consider buying MT now that everyone is waiting for the good news to come (you know, when they will come is usually too late to act).
Disclosure: I am long MT