ArcelorMittal (NYSE:MT) has announced that it will write down the value of its European business by about $4.3 billion in the fourth quarter because of the economic downturn that has resulted in gloomy prospects for steel manufacturers in the region. The writedown will be recorded in the form of a non-cash impairment to earnings for the quarter. Considering the twin factors that ArcelorMittal has recorded net earnings of more than $4.3 billion only once in its history (in Q2 2008) and the industry is not in the best shape right now, it seems likely that it will record an overall loss this quarter. 
Since the writedown is not on physical assets but due to an anticipated prolonged demand slump, the impairment will be recorded as a hit to goodwill. Whichever way one may choose to slice it, the company’s earnings are almost certain to be in red this quarter as well.
ArcelorMittal recorded a net loss of $709 million in the third quarter this fiscal year and the factors blamed for poor performance at the time remain unchanged. If anything, due to this massive impairment, we are now bracing ourselves for a particularly unpleasant quarterly result. The latest news has just compounded the problems ArcelorMittal is facing on multiple fronts. 
How Bad Is the Situation In Europe?
According to ArcelorMittal, demand for steel in Europe has fallen by 8% this year alone, and by around 29% since 2007. Austerity drives by governments, in view of the sovereign debt crises afflicting a number of countries in the region, have dented demand for steel in the automotive and construction sectors. These two segments are the major customers for steel. Also, the economic slowdown in China has compounded problems for the industry. 
The steel manufacturing capacity in Europe stands at around 210 million tonnes, of which only 155 million tonnes is being utilized at the moment. Hence, industry analysts had been expecting some plant closures in addition to the impairment charge announced by ArcelorMittal. 
We think that the company might be going slow on the plant closure aspect in light of the political backlash it experienced a few weeks back when it tried shutting down two blast furnaces at Florange in France. There was a huge uproar, stoked by politicians of various hues, accusing ArcelorMittal of breaking its promises to France. A lot of rhetoric, threatening nationalization of the entire Florange site, was heard in the press. After a high-profile meeting between the French President Francois Hollande and ArcelorMittal CEO Lakshmi Mittal, a compromise was worked out which eventually meant that the blast furnaces would continue to remain idle, but won’t be shut down. 
The blast furnaces at Florange, if kept open and idle, would cost the company anywhere between $20-40 million annually. This represents a significant cost for a company operating in a market struggling with excess structural production capacity. It would also endanger an asset optimization program the company has put in place to generate $1 billion in savings annually. 
Fitch Downgrades ArcelorMittal On Writedown News
The impairment announcement caused rating agency Fitch to downgrade ArcelorMittal’s credit rating to BB+, which is one notch below investment grade. This follows moves by S&P and Moody’s which did the same in August and November, respectively. With a debt rating below investment grade by all three major rating agencies, ArcelorMittal will find it very difficult to raise debt on favorable terms. The downgrade in rating of debt would mean higher interest rates, or coupons, for ArcelorMittal on any new issues. 
The company is already struggling with a massive debt burden of $23.2 billion, as reported at the end of Q3 this year. 
Let’s face it. The economic conditions in Europe are unlikely to improve anytime soon. The only way out for now seems to be an asset-sale program designed to get rid of unproductive and non-core assets. Operating costs on these serve as a drag on profitability, which ArcelorMittal can ill-afford at the moment. The complexity involved in selling these assets has already been witnessed by all in the French blast furnace closure attempt. Taking a cue from the success of the French government in prevailing over ArcelorMittal, workers elsewhere may put pressure on their governments to halt any attempts by ArcelorMittal to sell assets in their home countries. It will be a challenge the management at ArcelorMittal will have to contend with.
In short, there are no easy options and there is no easy way out. The steel manufacturing industry is cyclical in nature and there is only so much that can be done in the downward part of the cycle. The company has to find a way to shed assets and focus on markets like the U.S. which are doing relatively well as demand is up in view of a nascent economic recovery.
We have a price estimate for ArcelorMittal of $15 after the third quarter earnings results.Notes:
- Arcelor Takes $4.3 Billion Write-Down on Europe, WSJ [↩]
- China’s Weakness Continues To Pummel ArcelorMittal, Trefis [↩]
- ArcelorMittal takes $4.3 billion writedown on weak Europe, Firstpost [↩]
- ArcelorMittal writes down value of European businesses, Montreal Gazette [↩]
- Can The ArcelorMittal-France Truce Last?, Trefis [↩]
- ArcelorMittal Faces Quandary in French Call for Nationalization, WSJ [↩]
- Fitch downgrades ArcelorMittal to below investment grade, Steelguru [↩]
- ArcelorMittal’s Debt Plans Lead To Moody’s Downgrade, Trefis [↩]