ArcelorMittal (NYSE:MT) will release its third quarter earnings on Wednesday. We expect weaker revenues and profits compared to Q2 in the absence of any positive change in market conditions. The economic environment in Europe remains challenging and the nature of recovery in the U.S. is still fragile. The slowing Chinese growth is another area for concern.
While the automobile and construction sectors are showing encouraging trends, a full-fledged recovery continues to remain elusive. An economic recovery is expected in the long term so the long-term prospects are positive but near-term headwinds are not expected to subside soon.
ArcelorMittal is the world’s leading steel and mining company with a presence in more than 60 countries. It is the leader in all major global carbon steel markets, including automotive, construction, household appliances and packaging. The company also has a world class mining business with a global portfolio of over 20 mines in operation and development, and is the world’s fourth largest iron ore producer. With operations in over 22 countries spanning four continents, the company covers all of the key industrial markets, from emerging to mature and has outstanding distribution networks.
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Market Conditions Are Unfavorable
While the automotive sector in the U.S. remains relatively strong, the construction sector is showing only very moderate growth from low base levels. While demand from the private non-residential segment has weakened, billings from the architectural segment have been rising. In Northern Europe, output has decreased due to the continuing uncertainty over the debt crisis. In Southern Europe, the company says that the recession is deepening as austerity measures are being extended. This is causing consumers to cut back on spending and thus construction demand is weakening. The situation is particularly dire in Portugal, Greece and Spain.
The Chinese slowdown has led to a weakening of domestic steel prices and a collapse in the prices of iron ore. Since China is the world’s biggest consumer of iron ore, price movements in the Chinese market have had a major impact on worldwide prices. 
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, ArcelorMittal has in the past realigned its strategy to increase its focus on mining. However, the iron ore prices have slumped phenomenally since then. Q3 revenues from mining are expected to slump compared to the prior year’s comparable quarter. We expect this to more than offset any growth in mining production. Regardless, ArcelorMittal is still expanding its iron-ore business which is an important earnings driver for the company. This comes at a time when weak steel markets have dented its earnings and caused ratings agency Standard & Poor’s to downgrade the company’s credit status to junk from investment-grade. The company is projecting a growth in iron ore output to 84 million tonnes in 2015 from the 2011 figure of 54 million tonnes.
ArcelorMittal has been shedding assets, selling $2.7 billion of non-core assets since September 2011. The company has said that it plans to reduce debt through additional cost cuts and further sale of non-core assets in the coming months. ArcelorMittal has also shut down many of its European plants due to weak demand and may have to shut more. According to bankers, selling iron-ore assets in the current market environment could be challenging given the recent volatility in iron-ore prices. 
Steel Prices to Weigh on Earnings
We expect average realized prices to decline across the segments as steel prices on the London Metal Exchange (LME) are trending lower compared to the previous quarter. The unfavorable market conditions described above have contributed to the decline in steel prices on LME. ((Steel Billet Prices, LME))
Bullish In The Long Term
An economic recovery in the long term should benefit steel companies, including ArcelorMittal. A lot of the negative sentiment already seems to be factored into the current stock price. Until the economy recovers, we don’t see demand for steel increasing substantially.
We have a price estimate for ArcelorMittal of $18, which will be revised after the third quarter earnings results are declared.
While we believe in the long term prospectus of the company, we remain cautious in the near term due to high volatility in the company’s stock price, which is highly correlated with steel prices.Notes:
- HSBC Steel And Metals Fieldtrip Presentation, ArcelorMittal Investor Relations [↩]
- ArcelorMittal Weighs Stake Sale at Iron-Ore Business, WSJ [↩]