Does a Low Price Make This Giant a Buy?

Waqar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Headquartered in Luxembourg, AreclorMittal (NYSE: MT), is the world’s largest steel producer. Just like all major steel stocks, ArcelorMittal has also become a victim of low steel prices. On July 20, shares closed at $12.72, down 26% on a year-over-year basis. With steel prices facing an uncertain future, two key questions arise:  What does 2013 have in store for the company? Has ArcelorMittal bottomed?

Recent developments:  ArcelorMittal abandons Indian project

Recently, ArcelorMittal announced that it would be abandoning its plan to build a steel plant in India amid delays in acquiring an iron-ore mine and land. The company wanted to build a 12 million tons-per-year (MTA) plant in the Indian state of Odisha. Earlier, a steelmaker from South Korea, POSCO, did the same thing in the Southern state of Karnataka. POSCO had plans of building a 6 MTA plant, but due to delays in iron-ore mining rights and land acquisition, the company was forced to abandon the project.

As global steelmakers battle low prices, companies have been keen on investing in countries like India, where the cost of iron-ore mining is relatively low. If the project had gone through, the company's average cost per ton would have gone down considerably in the long run.

First-quarter results

In the first quarter of 2013, ArcelorMittal reported a net loss of $345 million versus a profit of $92 million during the same quarter last year. Sales were down 13% to $19.8 billion, while the steel shipments declined by 6% to 20.9 million metric tons.

While sales declined from 2012’s first quarter, they were up 2% from the last quarter of 2012. The same goes for steel shipments, which increased 5% from the fourth quarter of 2012.

The closing of operations in some parts of Europe is finally helping ArcelorMittal. The company's chairman, Lakshmi Mittal, said that while the first-quarter results were “still not satisfactory, at least I am starting to see the benefits of the actions we have taken.” In other words, reduced capacity is favoring the company in the European region.

Going forward

In 2013 and onward, ArcelorMittal expects to mint substantial revenue from the booming auto sector in the United States. Further, the company would also benefit from an improved U.S. housing sector. However, the company isn’t that optimistic about drill-pipe demand in the country. As far as Europe is concerned, low steel demand continues to be a big worry for the company. If Europe’s demand continues to slide, ArcelorMittal might close down its Eastern Europe plants as well.

During the third quarter, analysts expect ArcelorMittal to earn $0.09 per share on total revenue of $20.7 billion. For the full year, analysts’ estimates stand at $0.21 a share on slightly less than $82.0 billion in revenue.

Valuation

ArcelorMittal is trading at a low forward P/E (one year) of 11.8, making it a cheap buy in the steel industry. It’s yielding a high dividend of 5.4% and has a low PEG of approximately 1.9. This low PEG makes it an undervalued stock. A mean recommendation of 2.3 on the sell side also shows that ArcelorMittal is one of the better buys in the steel industry.

Steel industry’s major players

The largest mini-mill steelmaker in the United States, Nucor (NYSE: NUE), reported earnings of $85.1 million in the second quarter 2013 compared to $112.3 million in the same quarter last year. Having said this, Nucor’s books still show the company's strong liquidity. Strong cash flow from operations of $485 million in the second quarter shows that it can keep on paying healthy dividends to its shareholders even in an economic downturn.

Nucor has a forward P/E (one year) of 13.3, making it slightly more expensive than ArcelorMittal. It yields a dividend of 3.2% and has a mean recommendation of 2.1 on the sell side.

In the third quarter, Nucor is expected to post slightly better results thanks to a small price hike in the U.S. market. Hence, I recommend buying Nucor for the short run. But, as the future of steel prices remains uncertain, I am neutral on it in the long run.

On the other hand, Steel Dynamics (NASDAQ: STLD) posted net income of $29 million in the second quarter, down $15 million from last year’s second quarter. Low prices for sheet and structural steel were the chief culprits behind this dull performance. China’s sluggish growth accompanied by Europe’s weak demand also contributed to weak earnings. Plus, rising imports in the U.S. put downward pressure on steel prices.

Steel Dynamics has a dividend yield of 2.9% and has a low forward P/E (one year) of 10.1, making it slightly cheaper than Nucor. Just like Nucor, Steel Dynamics is expected to do well in the next quarter due to relatively better steel prices, making it a good buy for the short run.

Conclusion

By shutting down Europe’s high-maintenance plants, ArcelorMittal has done a great job. This can not only help the company in increasing its margins in the future but could also keep its focus in the right region. During the last five years, ArcelorMittal’s share price has fallen by a shocking 80%. Better performance during the first quarter (compared to the 2012 fourth quarter) reveals that the worst is over for the company. In short, its share price has bottomed.

Since the first week of July, U.S. steel prices have increased due to a temporary shortage of steel in the local market, giving a slight impetus to steel prices. As a result, ArcelorMittal is expected to post an increase in its earnings during the next quarter, making it a worthwhile buy for short term. Plus, this low price makes it even more attractive.

ArcelorMittal’s high beta of 2.4 clearly reflects the fact that it’s a cyclical company, depending largely on economic conditions. Europe’s slow economic growth could further dampen global steel prices, reducing the company’s margins further. As ArcelorMittal’s long term future depends on Europe’s economic recovery, I would remain neutral on it in the long run.

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Waqar Saif has no position in any stocks mentioned. The Motley Fool recommends Nucor. The Motley Fool owns shares of ArcelorMittal. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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