What’s Driving A 60% Decline In ArcelorMittal’s Profitability?

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Arcelor Mittal

ArcelorMittal (NYSE: MT) is witnessing a double whammy with projections of decreasing revenues and lower margins. The company’s profitability is expected to decline by more than 60% in a year, with Trefis projecting its net income to drop from $5.15 billion in 2018 to $1.85 billion in 2019, translating into a net income margin of 2.5% in 2019, significantly lower than the 6.8% recorded in 2018. Deterioration in its financials is expected to be driven by a decrease in steel prices, on the back of the US-China trade war and slowing global economic growth, along with higher iron ore prices which are expected to further eat into MT’s margins.

You can view the Trefis interactive dashboard – ArcelorMittal: Cost And Profitability Analysis – to better understand the factors causing a sharp decline in margins, and alter the assumptions to arrive at your own estimates of revenue, expenses, and profits for the company. In addition, here is more Materials data.

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Revenue Performance

  • For the full year, we expect revenue to decline by about 2.7% to $74 billion in 2019, and further by 0.7% to $73.5 billion in 2020, primarily driven by lower Chinese demand during the year.
  • The company projects a decline of 0.5%-1.5% in demand from China in 2019, as relatively stable demand from automotive and construction is offset by declining machinery output. This is in contrast to a demand growth of 3.5% in China during 2018.
  • Though ArcelorMittal has minimal exposure to China, a slowdown in Chinese demand and lower world economic growth, exacerbated by the US-China trade war, have led to a sharp drop in global steel prices in 2019.

To understand segment-wise revenue performance in detail, please refer to the following analysis by Trefis- ArcelorMittal Revenues: How Does ArcelorMittal Make Money?

Expenses and Profitability

Total expenses are expected to increase from $70.89 billion in 2018 to $72.15 billion in 2019. Increase in cost of sales is the primary factor for the drop in profitability, which is likely to be partially offset by lower interest expense and marginal drop in general and administrative cost

  • Cost of Goods Sold (COGS): COGS as % of revenue has remained almost flat over the last 3 years. However, with a sharp fall in steel prices in 2019, per ton realization is expected to go down. Steel price per metric ton has gone down from over $800/metric ton in January 2019 to close to $600/metric ton in September 2019. Additionally, a sharp rise in iron ore (raw material) prices in 2019 would lead to a further rise in the cost of steel sold. Iron ore price increased from $76/ton in Jan. 2019 to $120/ton in July 2019. Thus, COGS as a % of revenue is expected to jump significantly from 88.2% in 2018 to 92.6% in 2019.
  • SG&A Expense: Though SG&A expense increased in 2018 on the back of the Ilva acquisition cost and R&D expenses, as a % of revenue it registered a decline due to an increase in revenue in 2018. However, in 2019, the company’s SG&A expense is expected to decline in the absence of major acquisition-related charges. As a % of revenue, SG&A is expected to remain flat in 2019.
  • Income from Associates and JV: The metric increased in 2018 due to a gain realized on currency translation reserve and on sale of part ownership in China Oriental. Assuming the absence of major currency gains, income from investments is expected to slightly decrease in 2019.
  • Finance Cost: Finance cost shot up in 2018, mainly due to fair value adjustment on call option and foreign exchange losses. However, with value adjustment on call options on mandatory convertible bonds, and pellet purchase agreement already realized, and with dollar remaining relatively stable in 2019, we expect the net finance cost to see a sharp reduction, with the expense as a % of revenue decreasing from 2.9% in 2018 to about 2% in 2019.
  • Tax Expense: Tax benefits were realized in 2018 due to significant deferred tax benefits. In 2019, we expect the company to incur tax expense, with tax as a % of revenue to be around 0.4%, slightly lower than the 2017 level due to a drop in pre-tax profits on the back of lower gross margin.
  • Net Income to Non-controlling Interests: Net income attributable to non-controlling interests is also expected to decline due to a drop in the overall profitability of the company.

Thus, net income is expected to drop from $5.15 billion in 2018 to $1.85 billion in 2019, which marks a decline of about 64% in profitability, driven by the double whammy of decreasing revenue and the increase in total expenses on account of lower steel prices and higher iron ore prices. However, expectations of raw material prices stabilizing after a drop in the second half of 2019, along with productivity gains under MT’s Action Plan 2020, could drive a marginal improvement in profits for 2020.

 

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