2 Steel Producers To Buy, 1 To Avoid
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After seeing the depths of the financial crisis bring major iron & steel makers, like US Steel, to their knees, many investors are, understandably, on the sidelines. However, this has caused otherwise solid producers to become substantially undervalued. While I am attracted to ArcelorMittal (NYSE: MT) and Gerdau (NYSE: GGB), I believe that Nucor (NYSE: NUE) is not worthy of an investment.
ArcelorMittal & Gerdau
I remain particularly optimistic about ArcelorMittal given that valuation credit is really just being limited to the steel line as opposed to the iron ore line. Fears about debt covenants being breached (stemming from previous debt levels being hit 2 quarters before analyst expectations) have proved to be unreasonable. There is still considerable risk arising from Chinese steel ramp up. Even still, free cash flow is expected to take off from around -$1.3 billion in 2011 to positive territory in 2012 and $2.5 billion in 2013. Capital expenditures are likely to shrink as a percent of revenue and certainly drop off from high levels in 2011.
At less than 6x forward earnings, ArcelorMittal is pretty much a "why not?" story. The book value is worth more than 2x the book value, which would make the company an excellent play for stripping assets to firms looking for inorganic scale. Consensus estimates for ArcelorMittal's EPS forecast that it will grow by 50% to $1.95 in 2012 and then by 67.7% and 19.9% in the following two years. With a 5.1% dividend yield, the stock is not even as risky as many believe. Yes, dividends were halved during the 2008 collapse, but the macroeconomy is now heading in the right direction.
Gerdau is even cheaper on a forward earnings basis than ArcelorMittal and will likely follow the latter in terms of multiples expansion. What makes the company particularly attractive is that it has not experienced shipment declines due to macro uncertainty yet. Brazil has seen rising demand for bars and steel beams at the same time that prices have held up fairly well. And although costs have been high, Latin American and domestic businesses have at least provided more visibility than usual. A BRL 10 billion investment in productivity improvements showcase management's long-term views on the fundamentals.
In addition, Gerdau also has the benefit of strong operating flexibility, which it owes to its electric arc and blast furnace. This will enable the company to steer clear of any macro disasters should they arise. Moreover, the firm has strong geographical diversity that enables it to further improve its ability to navigate a challenging environment. Costs are meanwhile kept low through cheap Brazil labor - three-fifths of business ultimately comes from Latin America.
Nucor has neither the strong operating flexibility of Gerdau nor the attractive multiples of ArcelorMittal. It trades at a relatively high multiple of 16x past earnings, and, despite offering a 3.9% dividend yield, earnings are unlikely to outperform against the prospects of consolidation elsewhere. However, as the largest domestic mini-mill steelmaker, it is also looking to expand in scale. But the market has become concentrated, and the pricing power is now tightly controlled.
In the beginning of this year, the company unveiled an interest in expanding special bar quality production. Management approved $290 million for projects in TN, Norfolk, Darlington, and Memphis, among others, that will help it expand SBQ and wire rod capacity by a total of one million tons. These projects will be cleared by the end of next year and represent a major catalyst for shareholder value. With that said, cash is on the downward trend and will make the company vulnerable to any short-term liquidity problems. Inventory changes can be very volatile in iron & steel, so I recommend avoiding this stock if you are faint in heart.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of ArcelorMittal. Motley Fool newsletter services recommend Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.