Why is ArcelorMittal Steel Still so Cheap?

By Daniel Ferry - June 3, 2012 | Tickers: MT, NUE, PKX, X | 0 Comments

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ArcelorMittal (NYSE: MT) is the world's largest steelmaker, providing nearly a tenth of the world's steel, and about a fifth of the world's automotive steel. It is a vertically-integrated operation, with iron and coal mines, recycling plants, steel mills, and down-stream distribution centers spanning four continents. It is the world's fifth-largest iron ore miner, sheltering the company from volatile commodity prices. It is capably led by CEO Lakshmi Mittal, who has spent over two decades building his small family business into ArcelorMittal. It is expanding rapidly into developing markets, which now account for 80% of global steel consumption, and is already the largest producer in Brazil and Africa. And it is selling for peanuts.

Today, the company trades for just over a third of book value, and only a fifth of sales. Yes, steel prices have been weak throughout the recovery. Demand growth has been slowing in emerging markets, and demand in the developed world has stagnated or declined as Europe faces the prospect of another full-blown recession. But these headwinds affect the entire industry, and a comparison with other large public pure-play steel companies makes ArcelorMittal stand out as particularly undervalued.

ArcelorMittal is selling for less than its peers relative to book value or earnings, while maintaining the highest margins and most conservative debt-to-equity ratio. So: why is ArcelorMittal so cheap?

Some analysts have raised concerns over ArcelorMittal's debt load. While ArcelorMittal does have a more favorable balance sheet than many of its competitors, the entire industry has found itself deeply leveraged after the bottom fell out of the steel market during the recession. In ArcelorMittal's case, large and unfortunately-timed acquisitions forced the company to cut its dividend and dilute shareholder value by issuing new shares. However, ArcelorMittal has moved aggressively to pay back debt without risking growth prospects. The company is strategically selling off non-core assets and reallocating steel production to its most efficient facilities, cutting costs while retaining market share. CFO Aditya Mittal (Lakshmi Mittal's son) announced that he expects the company to hit its debt target in the second quarter, and may reduce it further. In a worst-case scenario, the company could avert catastrophe by reducing capital expenditures and dividends. Management is confident that the debt is serviceable, however, and plans to maintain current investment and dividend payments. Though high debt will remain a concern throughout the industry, ArcelorMittal's initiative to shore up its balance sheet will protect investors while leaving it in a better position than its rivals to pursue acquisitions when the market recovers.

 The stock may be oversold due to concerns over ArcelorMittal's idling of several steel mills in France and Spain, as well as the permanent closure of a Belgian mill. While this could be interpreted as a sign of weakness, I see it as a demonstration of the powerful advantage of ArcelorMittal's geographic reach. Diversified operations near many markets give ArcelorMittal the ability to easily expand production near high-demand markets, and cut costs by reducing or eliminating production in slower areas. Some of the largest costs in the steel industry are involved in transportation from mine to mill to market, and ArcelorMittal's geographic flexibility allows it to adapt to changing market conditions quickly and efficiently. Not for nothing does the company enjoy higher margins than its peers. Faced with deteriorating demand in Europe and strong growth in Africa and the Americas, ArcelorMittal has reinvested the savings from shuttering European plants into expanding operations in Brazil, Canada, and Liberia.

Ultimately I believe the company is cheap simply because the market is short-sighted. The steel market may remain weak through 2012, and though a recovery in demand at some point is inevitable, if it's not happening next quarter then the market doesn't care. For patient investors, ArcelorMittal looks attractive. Downside is limited by the company's ability to control capital expenditure to manage debt, as well as its current historically low valuation. On the upside, while over the past decade it has traded at around two times book value, even a return to a modest valuation of one times book value would provide a 150% return to investors today. To top it all off, a dividend yielding 4 – 5% can tide investors over while waiting for the stock to pop.

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