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Value Idea Update: ArcelorMittal (MT)

March 20, 2013 | About:
Chandan Dubey

Chandan Dubey

99 followers
ArcelorMittal (MT) is the world’s largest integrated steel and mining company. It is a result of a merger between Mittal Steel and Arcelor, which were at the time of merger, the largest and the second largest companies in the world.

ArcelorMittal’s footprint runs over 20 countries and four continents. In recent years it has tried to vertically integrate it operations by cutting out the iron and the coal producers. In the year ended Dec. 31, 2012, ArcelorMittal produced enough iron ore to meet 61% of the company’s requirement. It also produced 20% of the company’s coal requirements.

ArcelorMittal operates in a highly cyclical and commoditized industry. One of the principal factors affecting its profitability is the gap between the raw material prices and the finished steel products. The cost of the steel and the raw materials rise and fall together. This poses a challenge for manufacturers like ArcelorMittal. When the steel price is high, they might be working through a low-cost inventory and hence get higher profitability. Similarly, when the steel price is down, they might be working through raw materials acquired at high prices. This leads to “price-cost squeeze” and in turn, lower profitability and in some cases, a loss.

In an environment of high fluctuations (as now), small scrap mills turning scrap into finished products are less exposed to such volatility (e.g. Nucor (NUE)).

A solution is to own and produce your own raw material. This gives the company more control on the pricing of the end products. At least in the case of iron ore and coal, ArcelorMittal’s strategy is a great way to smooth out the price volatility of the raw materials. On the downside, as the mining segment starts contributing a larger and larger fraction of the company’s profitability, the fluctuation of prices of iron ore and coal will affect the profitability in any case.

Cash = $4.4 billion

Total Debt = $26.3 billion

Employee benefits = $7.1 billion

Shares = 1.55 + 0.104 + 0.134< 1.58 billion

Market Cap = $22 billion (Price: $13.91)

EV = $51 billion

Book value - Goodwill = $46.4 billion

To tackle its debt, ArcelorMittal has initiated a four-pronged approach: 1) no growth capex 2) cutting the dividend from $0.75 a year to $0.20 a year 3) asset sales and 4) nearly $4 billion in new equity offering. The terms of the last item are as below.

On Jan. 14 and 16, 2013, ArcelorMittal closed its offerings (the “Combined Offering”) of ordinary shares and mandatorily convertible subordinated notes (“MCNs”), respectively. The total aggregate proceeds from the Combined Offering were approximately $4.0 billion .... ordinary shares offering represented ... $1.75 billion ... approximately 104 million ordinary shares at an offering price of $16.75. The MCN offering ... $2.25 billion ... mature in January 2015, were issued at 100% of the principal amount and will be mandatorily converted into ordinary shares of ArcelorMittal at the maturity of the MCNs ... MCNs bear interest of 6.00% per annum,... The minimum conversion price of the MCNs is $16.75 ... the maximum conversion price was set at $20.94. The Mittal family participated in the Combined Offering by acquiring $300 million of MCNs and $300 million of ordinary shares.

Just to remind you, the Mittal family holds 39.35% of the shares outstanding.

The approach of reducing indebtedness is working quite well. The debt has gone down from $32.5 billion in the third quarter of 2008 to $21.8 billion at the end of the fourth quarter of 2012. Meanwhile, the average debt maturity has also gone up from two years to six years. In 2013, the company plans to use all generated cash to reduce the debt further. The medium-term target is a net debt of $15 billion.

With EBITDA of nearly $7 billion 2012 and $10 billion in 2011, there is no immediate balance sheet threat to the company. The company also had $1.76 billion in FCF for 2012.

A Posco (PKX)-led consortium acquired 15% of ArcelorMittal Mines Canada for $1.1 billion, valuing the subsidiary at $7.3 billion. The first part of the sale was completed March 15, 2013. They expect to wrap up the sales in the second quarter of 2013.

Bottom Line

The steel sector is battling with over-capacity and low demand. Given the increased uncertainty and the weakness in the market, it is hard to tell when the things will come around. But with its vertical integration (iron ore and coal production) and improving balance sheet, ArcelorMittal is well positioned to reap the benefits.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.0/5 (10 votes)

Comments

tonyg34
Tonyg34 - 1 year ago
tough ride

best of luck
cdubey
Cdubey - 1 year ago
Well, I am not worried. It is quite difficult to find a management you can trust. I like the management and plan to stick with them. I will continue adding on weaknesses ... I don't have a huge position (only 3% of my portfolio) but am willing to increase it to 10%, if the price is right.
jjmrocha
Jjmrocha - 1 year ago
And what is the right price, for you?
cdubey
Cdubey - 1 year ago
In my humble opinion the company is worth > $24 a share. The number is based on the "normal" operations of the company. In a normal environment, I would expect the company to have $100 billion in sales with at least 6% net margin. This would mean a $6 billion earning. I would gladly pay $36 billion (6 x earning) + $26 billion (net debt) for the company, which means around $24 per share.

Given this and because of the commodity like business and the cyclicity, I am willing to make a substantial position below $12 per share.
yoramhtm
Yoramhtm premium member - 1 year ago


Thank you
cdubey
Cdubey - 1 year ago
I bought 150 more shares yesterday at $13.3 a share.
larrypettit
Larrypettit - 1 year ago
I don't have a huge position。

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Dr. Paul Price
Dr. Paul Price premium member - 1 year ago


Larry,

That was funny and subtle.
Nicolas73
Nicolas73 premium member - 1 year ago
Hi Chandan, are you building your MT position up to 10%?

I imagine the price is right now (< 12$)

MritikCapital
MritikCapital - 1 year ago
Hi Chandan,

What is your preference of MTCN vs MT? The company is a tough business but I am willing to dig further to see if there may be a reasonable risk reward proposition here.
cdubey
Cdubey - 1 year ago
@Nicolas73: I am building my position. I now hold 800 shares.

@MritikCapital: I understand that the note give you better safety in case the company files for bankruptcy i.e., they come prior to equity holders, and offer you a confirmed dividend yield of 6% -- which is not too shabby. The downside is that you may have to buy shares between $16.75-$20.94, depending on the price of the shares around the maturity.

I am not betting on MT going bankrupt. The shares trade for $13. I will buy the shares instead of the convertible at these prices.

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