A few days after S&P downgraded ArcelorMittal (NYSE:MT) to junk rating of BB+, another prominent rating agency Fitch has downgraded it to BBB-, just a notch above junk status. The rationale for this move was the challenging short-term outlook for steel markets, particularly in western Europe. Fitch reasoned that the macro-environment would impact ArcelorMittal’s ability to pare down its huge debt obligations. ((Fitch downgrades ArcelorMittal’s credit rating, Reuters, Aug 8))
Weak demand for steel makes debt reduction difficult
The growth rates have declined due to the prevailing weak macro-economic environment in Europe. Industrial and construction activities are witnessing a prolonged slump. As a result, the demand for steel has nosedived, resulting in the closure or mothballing of a number of steel plants. ArcelorMittal derives 35% of its revenues from Europe and the slump has hit its business very hard. In the previous quarter, the flat carbon steel Europe division saw average steel selling prices down by about 14%, whereas steel shipments slumped by 9% to 7.14 million tons. Long Carbon Americas and Europe shipments and average realized prices were also down. ((ArcelorMittal reports second quarter 2012 and half year 2012 results, ArcelorMittal Press Release, July 25))
The weak demand for steel implies less generation of cash which the company needs to reduce its debt. ArcelorMittal said that it had reduced its net debt by $1.6 billion in Q2 2012, but said that a further reduction of its $22 billion debt pile depended on further divestments. The rating downgrade signals that the debt reduction is expected to occur at a slower rate than previously expected.
ArcelorMittal plans to increase capacity utilization at its lower-cost production facilities; close down higher cost plants; and increase mining capacity over the medium term to improve profitability, diversification, and internal self-sufficiency. Fitch acknowledged that the company had been making good progress with non-core asset disposals and cost-saving programs, but contended that these measures will not fully offset the negative impact of weaker organic cash flow generation. ((TEXT-Fitch cuts ArcelorMittal to ‘BBB-’; outlook negative, Reuters, Aug 8))
What does a rating downgrade imply
The downgrade has been carried out for Long-term Issuer Default Rating (IDR) and senior unsecured ratings. The downgrade in rating of debt would mean extra interest expense for ArcelorMittal. The company, however, said that the extra expense would only be $100 million which we believe would have a minimal impact on its financials. ((Fitch Becomes 2nd Rating Company to Cut ArcelorMittal, Dow Jones Newswires, Aug 8))
Despite the recent rating setbacks, we believe in the long-term prospects of the company once growth returns.
We expect North American shipments and prices will remain relatively stable going forward, absent an unforeseen shock to the U.S. economy. We believe the Flat Carbon Americas segment will continue to show robust growth. Going forward, we expect the Long Carbon Americas and Europe segment, which is still the company’s biggest source of value by our analysis, to recover and show steady growth.
We recently revised our price estimate for ArcelorMittal from $22 to $18, implying a premium of about 10% to the current market price.