Soft Demand And Pricing Will Weigh On ArcelorMittal’s Results
ArcelorMittal (NYSE:MT) will release its second quarter earnings on August 1. We expect weaker revenues and profits on a sequential as well as year-on-year basis due to lower demand and falling prices.
The economic environment in Europe remains challenging and the consumption of steel in the U.S. fell at a faster rate than the reduction in production for the first five months, causing prices to fall.
China, the biggest producer and consumer of steel in the world, reported a low economic growth rate of 7.5% for the second quarter. The country is taking steps to reorient its economy away from an export growth model towards higher domestic consumption. The disappointing data for the manufacturing sector, which accounts for nearly 40% of the country’s GDP, bears this out. However, a slowdown in demand hasn’t led to curtailment in production. Chinese steel is thus flooding the world markets, putting further pressure on prices. [1]
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Weak Demand And Low Prices Will Weigh On Earnings
We expect average realized prices to decline across all segments as steel prices on the London Metal Exchange (LME) are trending lower compared to the previous quarter. The ongoing crisis in Europe, slow Chinese growth in the last few quarters and mixed performance of sectors in the U.S. economy have contributed to the decline in steel prices on LME. ((Steel Billet Prices, LME))
According to data compiled by Bloomberg, the usage of steel in the U.S. fell by 7.7% for the first five months on the year. The decline in consumption was greater than that in production, which led to a drop in prices. [2]
Meanwhile, demand for steel is slowing down in China due to a slump in manufacturing and construction activities. Benchmark steel prices have fallen by 7% so far this year. Also, the Chinese central bank has recently taken steps to squeeze liquidity in the system in order to discourage lending for speculation in the real estate market. We think that this may slow down construction activity, putting further pressure on demand for steel. [3]
However, despite a slowdown in domestic demand, Chinese steel mills haven’t curtailed production. The country’s steel output is in fact increasing and all the extra stock is flooding world markets, thus driving down prices. For the first six months of the year, Chinese steel exports rose by 12.8% year-over-year and at the current pace its output might reach 790 million tonnes by the end of the year. The highest output so far was recorded last year at 716.5 million tonnes. At a time when countries across the world are curbing output, a rise in Chinese output is a definite negative for steel prices. [4]
Steps To Reduce Debt And Boost Profits
Paring its debt burden is a high priority area for ArcelorMittal in order to regain its investment grade rating which has been downgraded to junk by major rating agencies. At the end of the first quarter this year, ArcelorMittal had a net debt of $18 billion on its balance sheet. The company is aiming to reduce net debt to below $15 billion in the medium term. It was expecting net debt to come down to $17 billion by mid-2013. The second quarter results will reveal if this target has been achieved.
ArcelorMittal has set itself an ambitious target of raising EBITDA per tonne of steel from $87 to $150 in the next 2-3 years. This is expected to be achieved through a combination of asset optimization, an increase in shipments, growth in the mining business, management gains and higher utilization rates at its facilities. We will find out if the company has made any progress on this front when it releases its quarterly results.
We have a price estimate for ArcelorMittal of $16, which will be revised once the earnings results are out.
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Notes:- China’s GDP growth slows to 7.5 percent, tests reform push, Reuters [↩]
- China Coking Coal Demand Falls, Will U.S. Steel Demand Pick Up?, MetalMiner [↩]
- What China’s Cash Squeeze Means for the Global Economy, Knowledge@Wharton [↩]
- China Crude Steel Output Is Set to Hit a Record, WSJ [↩]