ArcelorMittal’s Q1 Earnings Preview: Weak Market Conditions For Iron Ore And Steel To Negatively Impact Results

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ArcelorMittal (NYSE:MT), the world’s largest steel producer, will announce its first quarter results and conduct a conference call with analysts on May 7. We expect the company to report weak year-over-year results, given the sharp decline in iron ore prices over the last year and weak market conditions for steel. The decline in iron ore prices will negatively impact realized prices and margins for ArcelorMittal’s Mining division, its most profitable operating segment. In addition, weak market conditions for steel will weigh on the results of the company’s steelmaking divisions. The high level of steel imports to North America is likely to negatively impact the results of the company’s North American operations. Furthermore, the strengthening of the U.S. Dollar against global currencies is likely to impact price realizations for  ArcelorMittal’s steelmaking divisions, with the majority of the company’s steelmaking operations located in international jurisdictions. However, the company’s cost optimization initiatives are likely to partially offset the negative impact of weak market conditions for steel and iron ore. In Q4 2014, the company’s closely-watched earnings before interest taxes depreciation and amortization (EBITDA) figure fell around 5% year-over-year to $1.82 billion in Q4 2014, primarily due to the impact of weak iron ore prices on the results of the company’s Mining division. [1] In this article, we will take a look at what to expect from the company’s Q1 results. 

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Iron Ore Prices

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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 53% of the company’s iron ore shipments in 2012. [2] This figure rose to 59% and 62%, in 2013 and 2014, respectively. [1]

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. Benchmark 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. [3] Chinese steel demand growth is expected to decline by 0.5% in 2015, following on from a similar decline in 2014. [4] Weak demand for steel has indirectly resulted in weak demand for iron ore.

On the supply side, an expansion in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. [5] The worldwide surplus of seaborne iron ore supply is expected to rise to 300 million tons in 2017, from an expected surplus of 175 million tons in 2015, and a surplus of 72 million tons and 14 million tons in 2014 and 2013, respectively. [6] [7] A combination of weak demand and oversupply is likely to result in weak iron ore prices in the near term. Subdued iron ore prices will weigh on the results of the company’s Mining division in Q1.

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. [2]

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. [8] ArcelorMittal derives around 75% of its revenues from developed markets, including Europe and North America. [9] Over the course of the last year or so, steel prices have recovered in the North American Free Trade Agreement (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. However, there has been an increase in cheap steel imports into the U.S., partly because of the strengthening of the U.S. Dollar against global currencies. The penetration of finished steel imports as a percentage of the U.S. domestic steel market increased to 28.1% in 2014, up from 23.2% in 2013. [10] The increase in steel imports is likely to negatively impact realized prices and shipments for the company in North America. Over and above the competition from steel imports, the demand conditions for steel in North America may not be as robust as initially anticipated, with the World Steel Association revising downwards expectations of steel demand growth in the North American Free Trade Agreement (NAFTA) region to -0.9% in 2015, from previous estimates of 3.4% growth. [11] This is partly due to the high base effect, with demand increasing 12% in 2014, which was higher than expected. [4] Thus, weak market conditions for steel in North America are likely to negatively impact the results of the company’s NAFTA business segment.

We expect the company’s steel shipments to rise in Europe, given firming demand for steel in the region. As per World Steel Association estimates, steel demand is expected to grow at 2.1% in 2015 in the Eurozone. [4] However, pricing for the company’s European steel shipments as well as earnings for the division are expected to remain under pressure as a result of the depreciation of the Euro against the Dollar. In Q4 2014, average realized steel prices for ArcelorMittal’s Europe business segment fell around 10% year-over-year to $721 per ton. [1] Lower price realizations in Europe are expected to weigh on the company’s Q1 results as well.

Cost Savings and Debt Reduction

Given the weak steel pricing environment, ArcelorMittal’s cost optimization efforts have played a major role in boosted its margins. The company realized cumulative savings of $2.1 billion in 2013 and 2014. It is maintaining its emphasis on cost reduction with another $900 million in savings targeted for 2015. [12]

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. It has been selling off its non-core businesses in order to reduce its debt burden. The company has generated approximately $4.3 billion in cash proceeds from sales of non-core assets since September 2011. [13] Net debt for the company stood at $15.8 billion at the end of 2014. [10] The company has a medium term net debt target of $15 billion. [10] Earlier on in February, the company’s long-term credit rating was further reduced by Standard & Poor’s to BB from BB+. [10] With the latest ratings downgrade, the company is expected to continue with its policy of debt reduction, which may include potential asset sales in order to reduce the company’s debt. More information from the company regarding its debt management plans will throw some light on the road ahead for ArcleorMittal.

 

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Notes:
  1. ArcelorMittal’s Q4 2014 Earnings Release, SEC [] [] []
  2. ArcelorMittal’s 2013 20-F, SEC [] []
  3. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  4. Short Range Outlook 2015-2016, World Steel Association [] [] []
  5. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  6. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  7. Iron Ore Caps 2014 Loss as Morgan Stanley Says Worst Over, Bloomberg []
  8. Steel Billet Prices, LME []
  9. ArcelorMittal’s Investor Presentation 2014, ArcelorMittal Website []
  10. ArcelorMittal’s 2014 20-F, SEC [] [] [] []
  11. Short Range Outlook 2014-2015, World Steel Association []
  12. ArcelorMittal’s Q4 2014 Earnings Presentation, ArcelorMittal Website []
  13. ArcelorMittal’s Q3 2014 Earnings Presentation, ArcelorMittal Website []