ArcelorMittal Earnings Preview: Higher Steel Prices to Boost Q2 Results

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ArcelorMittal (NYSE:MT) will announce its second quarter results on August 1. A better pricing environment for steel in the second quarter of this year, as compared to the corresponding period a year ago, will boost the company’s results. Some of the gains from better steel prices will be offset by higher costs at the company’s North American Free Trade Agreement (NAFTA) business segment due to the impact of adverse weather conditions.

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Steel Demand and Prices

The principal consumers of steel products are the automotive, construction, appliance, machinery, equipment, infrastructure and transportation industries. The nature of business of these sectors is cyclical, with demand generally correlated with macroeconomic conditions. Thus, demand for steel products is generally correlated with macroeconomic fluctuations in the global economy.

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Steel prices have fallen over the last few years, driven primarily by falling demand due to adverse macroeconomic conditions in the developed economies and an oversupply situation. This is indicated by trends in the London Metal Exchange (LME) Steel Billet Prices. [1] Over the course of the last year or so, steel prices have recovered somewhat, driven by an economic recovery in the developed economies, particularly in the manufacturing sector. The Manufacturing Purchasing Managers Index (PMI) measures business conditions in the manufacturing sector of the concerned economy. When the PMI is above 50, it indicates growth in business activity, whereas a value below 50 indicates a contraction. This metric has consistently registered values of over 50 for all months in 2014 for the U.S. [2]  While it has faltered somewhat lately for the Eurozone, it has still remained above 50 for all months in 2014. [3] Steel demand in the NAFTA region is expected to grow at 3.8% and 3.4% in 2014 and 2015 respectively, up from a contraction in demand of 2.4% in 2013. Similarly, steel demand in the European Union is expected to grow at 3.1% and 3.0% in 2014 and 2015 respectively, up from a contraction in demand of 0.2% in 2013. ((Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association)) The improved demand conditions in Europe and North America bode well for ArcelorMittal as these markets account for two-thirds of the company’s steel shipments. [4] These improved demand conditions for steel are reflected in the LME Steel Billet Prices. These prices, which remained below $150 per ton for most of Q2 2013, remained higher than $350 per ton throughout Q2 2014. [1]

ArcelorMittal’s Automotive Focus

The company announced the opening of an automotive steel plant in the Loudi Economic Development Zone, situated in China’s Hunan province, in the second quarter. The plant is owned by Valin ArcelorMittal Automotive Steel Company (VAMA), a joint venture between ArcelorMittal and Hunan Valin Iron and Steel Company in which ArcelorMittal holds a 49% stake. The total investment in the plant was $832 million. [5]

The opening of this automotive plant in China is a part of ArcelorMittal’s strategic focus on automotive steel. Given the recovering demand and pricing environment for steel, automotive steel with its relatively high and stable margins, constitutes an important focus area for the company. [6] As per the company’s estimates, its flat products accounted for approximately 17% of the global automotive steel market in 2013. ((ArcelorMittal’s 2013 20-F, SEC)) Shipments of automotive steel accounted for around 16% of ArcelorMitttal’ s total shipments in 2013. ((ArcelorMittal’s 2013 20-F, SEC)) The company’s automotive steel shipments are mainly delivered in the regional markets of its production facilities in Europe, North and South America and South Africa. [7] With the addition of the Hunan automotive plant, the company will significantly expand in China as well.

ArcelorMittal’s management has reiterated its commitment to automotive steel as a major focus area in the company’s strategy. Thus, the company’s thrust on the automotive sector is set to continue. ((Global Natural Resources Conference, ArcelorMittal Company Presentation))

Debt Reduction

ArcelorMittal announced the sale of its stake in the European port handling and logistics company, ATIC Services S.A. to HES Beheer N.V. for an undisclosed amount, in the second quarter . [8] The transaction is consistent with the company’s strategy of selectively divesting its non-core assets in order to pare down its debt. The company has generated approximately $4.7 billion from asset sales from September 2011 to December 2013. [9]

Due to a high level of debt on ArcelorMittal’s balance sheet and a weak steel industry outlook, major rating agencies downgraded the company’s credit rating to junk status in 2012. This raised the cost of borrowing for the company. ArcelorMittal has since then embarked upon a concerted effort to pare down its heavy debt burden. Net debt for the company stood at $16.1 billion on December 31, 2013 down from $21.8 billion on December 31, 2012. [7] The decrease in net debt was primarily due to improvements in cash flow from operations and cash proceeds from divestments. The company’s net debt rose to $18.5 billion by the end of the first quarter, mainly due to investments in operating working capital, early redemption of perpetual securities and the payments for the acquisition of Thyssenkrupp’s steel plant in Calvert, Alabama. The company has set itself a medium term net debt target of $15 billion, though it has not specified an exact timeframe in terms of years. ((ArcelorMittal’s Q1 2014 Earnings Conference Call Transcript, Seeking Alpha))

Other Developments

The operations of the company’s NAFTA segment were negatively impacted by weather-related disruptions in both the first and second quarters. These disruptions resulted in a fall in steel production in the NAFTA region. The total negative impact of weather related disruptions on the company’s margins was $200 million in Q1 and is expected to be around $150 million in Q2.  The main component of the weather-related impact was a spike in natural gas prices, as well as the cost of distributing this gas to the company’s operations in Northwest Indiana. ((ArcelorMittal’s Q1 2014 Earnings Conference Call Transcript, Seeking Alpha))

Iron ore shipments from the company’s Mining division are expected to be higher in the second quarter, with the company on track to increase production capacity from 70 million tons in 2013 to 84 million tons in 2014. Further, marketable iron ore shipments, which are those shipments that the company sells to third parties, are set to increase by 15% in 2014, along with the overall rise in shipments. [4] Iron ore shipments are expected to rise in the second quarter as well, on a year-over-year basis.

Expectations from Conference Call

With the company management reiterating its commitment to its medium term net debt target of $15 billion in the Q1 Earnings conference call, we would like to know the specific steps that the company has identified for achieving this target. Further sales of non-core assets may be on the cards. More information on this front would throw some light on the road ahead for ArcleorMittal.

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Notes:
  1. Steel Billet Prices, LME [] []
  2. U.S. Manufacturing PMI, Trading Economics []
  3. Euro Area manufacturing PMI, Trading Economics []
  4. ArcelorMittal’s Q1 2014 Earnings Conference Call Transcript, Seeking Alpha [] []
  5. Valin ArcelorMittal Automotive Steel Co Inaugurates Landmark Automotive Steel Plant In China, ArcelorMittal Press Release []
  6. Global Natural Resources Conference, ArcelorMittal Company Presentation []
  7. ArcelorMittal’s 2013 20-F, SEC [] []
  8. ArcelorMittal Signs Sale And Purchase Agrement For Sale Of ATIC Stake, ArcelorMittal Press Release []
  9. Global Steel And Mining Conference 2013 Presentation, ArcelorMittal Website []