Two Scenarios That Could Impact ArcelorMittal’s Stock Price

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ArcelorMittal (NYSE:MT) is the world’s largest steelmaker. It is one of the leading global producers of automotive steel, accounting for around 16.7% of the world’s automotive steel sheet market in 2014. [1] The company is investing heavily to produce advanced high-strength steels for the automotive industry, in order to maintain steel’s position as the material of choice for the automotive industry.

Steel is facing intense competition from other materials such as aluminum as the material of choice for automobile manufacturers, as automakers look to reduce the weight of their vehicles in order to comply with increasingly stringent emissions and fuel efficiency regulations. For example, the U.S. government targets improvements in automobile fuel efficiency from 27.5 miles per gallon in 2012 to 54.4 miles per gallon in 2025. [2] In the EU, the target is to reduce average vehicular emissions from 130 grams of carbon dioxide per kilometer in 2015 to 95 grams of carbon dioxide per kilometer by 2021. [3] If aluminum eats into steel’s market share, the company’s automotive steel shipments could decline significantly, which would adversely impact the company’s prospects.

In addition, the company is amongst the largest producers of iron ore in the world. 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. Market-priced shipments accounted for around 53% of the company’s iron ore shipments in 2012. [4] This figure rose to 59% and 62%, in 2013 and 2014, respectively. [1] The results of ArcelorMittal’s Mining division have suffered due to a sharp decline in iron ore prices over the course of the last year. Benchmark 62% Fe iron ore fines prices stood at $58 per dry metric ton (dmt) at the end of March, around 48% lower on a year-over-year basis [5]. Iron ore prices have declined due to a combination of weakness in demand and rising global iron ore production, resulting in an oversupply situation. Demand for iron ore has been negatively impacted by a slowdown in economic growth and demand for steel in China, which accounts for over 60% of the seaborne iron ore trade. [6] The supply side is characterized by an expansion in production by major iron ore mining companies. Companies such as Vale, Rio Tinto, and BHP Billiton are rapidly ramping up their iron ore production, despite weakness in demand. These companies have low-cost iron ore deposits and are able to operate profitably even at current price levels. [7] A combination of weak demand and oversupply has negatively impacted the prospects of ArcelorMittal’s Mining division.

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We expect iron ore prices to remain subdued in the near term, with prices recovering gradually only after the global supply glut dissipates. However, there is a possibility of a sharper V-shaped recovery in prices, if sufficient high-cost iron ore supply goes out of the market. The current level of iron ore prices is too low to sustain significant quantities of high-cost iron ore production, particularly from domestic Chinese iron ore producers. Production cutbacks in response to low prices are likely to result in a more favorable demand-supply equation, which would boost iron ore prices. Such a scenario would significantly boost the prospects of ArcelorMittal’s Mining division.

We have explored the impact of these two scenarios on the company’s stock price below:

Aluminum Dominates Steel in Automotive Market

ArcelorMittal’s automotive steel shipments stood at 13.3 million tons or 15.6% of the company’s overall steel shipments in 2014. [1] However, if aluminum becomes the material of choice for automobile manufacturers, the moderation in the growth in the company’s automotive steel shipments, would significantly retard the growth in the company’s overall steel shipments.

In order to model this scenario, we have factored in a gradual decline in our forecasts for the company’s automotive steel shipments, which has retarded the growth in our forecasts of the company’s overall steel shipments. We have also suitably modified our forecasts for margins for the company’s various divisions. These modifications to the relevant drivers in our model lowers our price estimate for the company’s stock by around 10% from $10.08 to $9.07. Thus, if aluminum dominates steel in the automotive market over our forecast period, a downward adjustment in valuation could potentially follow for ArcelorMittal.

See our complete analysis for ArcelorMittal in the Aluminum Dominates Steel in Automotive Market scenario

V-Shaped Recovery in Iron Ore Prices

The world’s lowest cost iron ore miners break even at price levels below $50 per ton. [8] Thus, these companies can continue to produce profitably even if prices fall further. However, the current levels of iron ore prices are insufficient for high-cost iron ore producers, particularly domestic Chinese iron ore miners. China is the world’s largest producer of iron ore. [9] Around 80% of Chinese domestic iron ore producers break even at prices levels of $80-90 per ton. [8] If prices remain at current levels for a long time, a significant proportion of these producers may be forced to cut back on production. Such a scenario would result in a more favorable global supply-demand equation which would boost iron ore prices.

If we assume that this scenario materializes and iron ore prices recover to around $80 per ton by 2017, it would significantly boost revenues and margins for ArcelorMittal’s Mining division, as compared to the assumptions currently factored into our stock price model for the company. If we factor in these assumptions into our model, our price estimate for the company increases by around 58% from $10.08 to $15.90. Thus, in the event of a sharp recovery in iron ore prices, an upward adjustment in valuation could potentially follow for ArcelorMittal.

See our complete analysis for ArcelorMittal in the V-shaped Recovery in Iron Ore Prices scenario

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Notes:
  1. ArcelorMittal’s 2014 20-F, SEC [] [] []
  2. Steelmakers Must Step On Gas To Keep Car Work, Financial Times []
  3. ArcelorMittal unveils Fortiform, a range of new advanced high strength steels for safer and lighter cars, ArcelorMittal News Release []
  4. ArcelorMittal’s 2013 20-F, SEC []
  5. Iron Ore Prices, Y Charts []
  6. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  7. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  8. Iron Ore Slump No Bar to Supply as China Mines Shut: Commodities, Bloomberg [] []
  9. Iron Ore Production, U.S. Geological Survey 2014 []