ArcelorMittal (NYSE:MT) will release its second quarter earnings on Thursday. On a year-over-year basis, we expect the company to post relatively weak earnings as lower steel prices coupled with weak demand in the oversupplied European market will weigh heavily on the results.
While Our current price estimate for ArcelorMittal stands at $22, a premium of about 45% to the current market price, we will revise our price estimate to reflect the weak steel prices and other developments post earnings announcement.
European Weakness Persists
We expect the company to see a decline in shipments to Europe as the market is still grappling with a slowdown. Following the global economic recession in 2008, European countries have been grappling with weakness in industrial and construction activities, which are major steel demand drivers. Demand for steel in Europe has plunged to 150-160 MTPA from as high as 200 MTPA in 2008.
ArcelorMittal has shut many of its European plants due to weak demand and may have to shut more. While we expect European demand to eventually pick up 2013 onward, the current scenario may lead to a further decline in sales from Europe. Exports, however, could offset some of the declines.
We expect ArcelorMittal’s North America business to remain relatively stable going forward on back of automotive and appliance sales. Further, we expect the company’s steel shipments in its Asia, Africa and the Commonwealth of Independent States (AACIS) division to increase primarily due to improved market demand in Africa. However, profitability could take a hit due to pricing pressure primarily in CIS.
Lower Steel Prices to Hurt
We expect average realized prices to decline across the segment as steel prices are hovering at two years low on London Metal Exchange (LME). The resurgence of the European debt crisis, slowing Chinese growth and mixed reports about the U.S. economy, all have contributed to the decline in steel prices on LME.
Based on data available from the London Metal Exchange (LME), the average steel price over the period Apr-Jun 2012 was significantly at close to $400 per ton compared with $550 per ton for the Apr-Jun 2011 period. 
Iron Ore Prices A Drag On Mining Earnings
Recognizing the growth potential and also to hedge against rising prices of major raw materials like iron ore and coal, the company has realigned its strategy to increase its focus on mining. We expect an increase in its mining output in the second quarter. However, the Q2 will be marked by a slump in iron ore prices compared with the prior year’s quarter. We expect this to more than offset the growth in mining production.
Optimizing Production, Declining Iron Ore Prices Could Support Margins
It is essential to run steel mills at optimal operating capacity in order to retain profitability. To combat weak demand and oversupply in Europe, the company has suspended production at some of its facilities while raising production to an optimal level in other. We believe that, even with lower steel prices, this should help the company’s EBITDA margins. Further, a dip in iron ore prices should also bolster margins to some extent.Notes: