ArcelorMittal Earnings Preview: Weak Steel Pricing In Europe And Lower Iron Ore Prices To Weigh On Q3 Results
ArcelorMittal (NYSE:MT) will announce its third quarter results on November 7. Economic weakness in Europe will weigh on the company’s results, as the region accounts for around half of ArcelorMittal’s revenues. The company is expected to report lower year-over-year price realizations from its European steel-making operations. Furthermore, lower year-over-year iron ore prices will negatively impact the results of the company’s Mining segment. However, a better demand and pricing environment for steel in North America this year, as compared to the corresponding period a year ago, will boost the results of the company’s North American Free Trade Agreement (NAFTA) business segment. In addition, the company’s ongoing cost reduction efforts will boost the company’s results.
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Steel 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. [1]
Steel prices have fallen over the last few years, driven primarily by weak 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. [2] Over the course of last year or so, steel prices have recovered in the NAFTA region, which consists of the U.S., Canada and Mexico, driven by an economic recovery in the U.S., 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. [3] This indicates strong manufacturing activity in the U.S., which was reflected in ArcelorMittal’s second quarter results. Average realized steel prices for the NAFTA segment rose 1.8% year-over-year from $841 per ton in Q2 2013 to $856 per ton in Q2 2014. ((ArcelorMittal’s Q2 2014 Earnings Release, SEC)) Steel demand in the North American Free Trade Agreement (NAFTA) region, , is expected to grow by 3.8% in 2014, as compared to a 2.4% fall in demand in 2013. [4] A strong steel demand and pricing environemnt in North America will positively impact the results of the NAFTA segment in the third quarter.
The Manufacturing PMI for the Eurozone has faltered somewhat lately, indicating slowing manufacturing activity. The Manufacturing PMI for the Eurozone, which stood at 54 for January 2014, has declined to 50.6 for October. [5] Sluggish manufacturing activity in the Eurozone was reflected in ArcelorMittal’s second quarter results. Average realized steel prices for the Europe segment fell 1% year-over-year from $807 per ton in Q2 2013 to $799 per ton in Q2 2014. ((ArcelorMittal’s Q2 2014 Earnings Release, SEC)) With faltering economic growth and manufacturing activity, as indicated by the manufacturing PMI figures, steel pricing is expected to remain weak in Europe. This will negatively impact ArcelorMittal’s third quarter results.
Iron Ore Prices
ArcelorMittal’s iron ore shipments are either transferred to its steel producing divisions on a cost-plus basis or sold at market prices, either to third parties or to the company’s steel producing divisions. The company is raising its proportion of market-priced iron ore shipments. Market-priced shipments accounted for 52.9% of the company’s iron ore shipments in 2012. [1] This figure rose to 58.9% in 2013 and to 65.6% in the first half of 2014. ((ArcelorMittal’s Q2 2014 Earnings Release, ArcelorMittal Website)) However, weak iron ore prices will negatively impact the results of ArcelorMittal’s Mining division on a year-over-year basis.
Iron ore is an important raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining its prices. International iron ore prices are largely determined by Chinese demand, since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. [6] Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015 respectively, from 6.1% in 2013. [7] Weak demand for steel has indirectly resulted in weak demand for iron ore.
On the supply side, expansion in production by majors such as Rio Tinto and BHP Billiton has created an oversupply situation. A combination of weak demand and oversupply is likely to result in lower iron ore prices in the near term. [8] Iron ore prices stood at $82.38 per dry metric ton (dmt) at the end of September, around 38% lower than at the corresponding point of time last year. [9] As per Goldman Sachs, the worldwide surplus of seaborne iron ore supply will rise to 175 million tons in 2015, from an expected 72 million tons for 2014 and 14 million tons for 2013. [10] In view of the persisting oversupply situation, iron ore prices will remain subdued in the near term.
Cost Savings and Debt Reduction
ArcelorMittal’s cost optimization efforts yielded savings of $1.1 billion in 2013. The company is set to continue with its emphasis on reducing costs with $2 billion and $3 billion in savings targeted in 2014 and 2015 respectively. [11] Given an uncertain demand and pricing environment for steel in Europe, which accounts for around half of the company’s revenues, cost reductions will play a major part in boosting the compay’s results
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 $17.4 billion on June 30, 2014, down from $18.5 billion on March 31, 2014. [12] The decrease in net debt was primarily due to release in operating working capital and proceeds from mergers and acquisition (M&A) activities. ArcelorMittal sold off its 50% stake in Gallatin Steel Company to Nucor Corporation for a total cash consideration of $770 million in the third quarter . [13]) 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. [14]
Expectations from Conference Call
With the company management reiterating its commitment to its medium term net debt target of $15 billion in the Q2 Earnings conference call, we would like to know the specific steps that the company has identified for achieving this target. [15] After the sale of its stake in Gallatin Steel in Q3, we would like to know whether asset sales will still play a part. More information on this front will throw some light on the road ahead for ArcleorMittal.
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Notes:
- ArcelorMittal’s 2013 20-F, SEC [↩] [↩]
- Steel Billet Prices, LME [↩]
- U.S. Manufacturing PMI, Trading Economics [↩]
- Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
- Euro Area manufacturing PMI, Trading Economics [↩]
- China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
- Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
- BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb [↩]
- Iron Ore Spot Prices, Y Charts [↩]
- Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg [↩]
- ArcelorMittal’s Investor Day 2014 Presentation, ArcelorMittal Website [↩]
- ArcelorMittal’s 2013 20-F, SEC [↩]
- ArcelorMittal and Gerdau Agree to sell Gallatin Steel Facility for US$770 million, ArcelorMittal Press Release [↩]
- Global Steel And Mining Conference 2013 Presentation, ArcelorMittal Website [↩]
- ArcelorMittal’s Q2 2014 Earnings Call Transcript, Seeking Alpha [↩]