ArcelorMittal (NYSE:MT) released its second quarter earnings on Wednesday, where it reported an expected drop in revenues and EBITDA as low steel prices and weak demand weighed heavily on the earnings. An increase in demand in the Americas and AACIS market wasn’t enough to offset sluggish European demand. Overall revenues were flat at $22.7 billion while EBITDA declined by about 23% to $1.97 billion. In line with expectations, overall shipments declined by 2.5%. 
We have revised our price estimate for ArcelorMittal from $22 to $18, implying a premium of about 10% to the current market price. The revision primarily reflects a reduction in our pricing and margins forecast. While we believe in the long term prospectus of the company, we remain cautious in the near term due to high volatility in the company’s stock, which is highly correlated with steel prices.
Steel Prices Take a Toll on Steel Business, Iron Ore Prices Drag Mining Earnings
The uncertain economic outlook in Europe has left the company struggling with weak demand in the region. The flat carbon steel Europe division saw average steel selling prices down by about 14%, whereas steel shipments slumped 9% to 7.14 million tons. Long Carbon Americas and Europe shipments and average realized prices were also down.
In the flat carbon Americas segment, shipments grew about 4% as improved consumer sentiment in the country continued to boost automotive and appliance sales. However, 8% decline in average realized prices led to a decline in EBITDA from this division.
ArcelorMittal’s steel shipments in its Asia, Africa and the Commonwealth of Independent States (AACIS) division rose marginally. However, profitability took a hit as pricing pressure in the Africa more than offset stable prices in the CIS market. Distribution Solutions revenue and EBITDA (excluding one time gain) also declined mainly on lower steel prices.
The second quarter was marked by a slump in iron ore prices compared with the prior year’s quarter. This more than offset the growth in mining production, which translated into a steep decline in mining earnings.
Short Term Headwinds Persist for Steel Business
European economic situation poses a significant risk to ArcelorMittal as it derives close to 35% of its revenues from Europe. We expect no immediate reprieve for the demand in the region. However, we forecast steel shipments to increase post 2012 in conjunction with an eventual economic recovery. Steel prices may also not recover soon.
We expect that North American shipments and prices will remain relatively stable going forward, absent an unforeseen shock to the U.S. economy. We believe Flat carbon Americas segment will continue to show robust growth. Going forward we expect the Long Carbon Americas and Europe segment, which is still the company’s biggest source of value according to our analysis, to recover and show steady growth. However, steel prices could spoil the mood, if they fail to recover even after capacity cuts across the globe.
Even as we expect healthy growth from the AACIS business going forward, recent developments in South Africa seem to be taking a toll on the company’s business in the country. In addition other emerging markets are also witnessing weaker demand. The recent price cut by China’s largest steel manufacturer BaoSteel could be signalling further deterioration of steel demand from China.
Margins Under Pressure in Near Term
Weak Steel prices have certainly led to a reduction in margins across the segments. However, as the economy recovers, margins will improve. Further, to combat weak demand and oversupply in Europe, the company has suspended production at some of its facilities while raising production to an optimal level in other. We believe that this will lend support to some extent as fixed costs will be reduced, and a dip in iron ore prices and management’s cost reduction efforts should also help margins to some extent.
Mining Focus Intact
ArcelorMittal reiterated its focus on mining operations and is moving aggressively to develop iron ore and coal mines, the two primary raw materials for the production of steel. The company aims to offset the rising cost of these raw materials by mining them in-house. We expect ArcelorMittal’s mining revenues to decline in 2012 primarily on weak iron ore prices. However, revenues may increase steadily thereafter throughout our forecast period, mainly on the back of increased production.Notes:
- ArcelorMittal reports second quarter 2012 and half year 2012 results, ArcelorMittal Press Release, July 25 [↩]