Energy producers, home builders and bankers have received most of the attention over the past few years for the gyrations of stock values, but the real star has been the humble steel-makers.
U.S. Steel (X), the iconic American industrial company, has seen its shares rise from a low of $9.50 in 2003 to a high of $195 earlier this year, a twenty-fold move that puts even most of the best tech moves of the 1990s to shame.
I’ve been very positive on steelmakers in my InvestorPlace letters over the past few years with India powerhouse ArcelorMittal (MT) actually being my very first recommendation in 2006 followed by Nucor (NUE), Chaparall (now gone in a merger) and most recently Gerdau (GGB) and AK Steel (AKS).
What’s so interesting about Mittal, now based in the Luxembourg after a brief stop in the Netherlands, is that it is still controlled by an Indian family and may be one of the most truly global companies in the world, as it manufactures steel in Algeria, Bosnia, Canada, Czech Republic, France, Germany, Kazakhstan, Mexico, Poland, Romania, South Africa, Trinidad-Tobago and elsewhere. It also runs steel-rolling plants in Luxembourg and Macedonia. About 65% of its revenue is generated in emerging markets. (Read more on "How to Invest in Emerging Markets" here.)
The company began its current incarnation in 2004 following the merger of a private Indian company called LNM Holdings with publicly held Ispat International and International Steel Group. Considering that it is the largest steelmaker in the world, is well-integrated vertically, has a very low cost structure and will achieve greater economies of scale going forward.
It should probably trade at a premium earnings multiple. And yet it actually trades at a discount—a paltry 7X forward multiple versus the 8X industry average.
The fundamental issue that distinguishes Mittal is that it is the leading acquirer in an industry that is consolidating, and its executives have managed to avoid buying assets too richly—a common trap.
As it obtains inefficient assets in places like Poland and the Czech Republic, it applyies its expertise and sensible, but not overly indulgent, capital expenditure budget to implement repairs and efficiencies that are driving up utilization rates. Its combination of low costs, diversified manufacturing base, modest long-term debt and light cap-ex has led to impressive cash flow—giving it the ability to raise its dividend, buy back shares and invest more.
One of the company’s key advantages is its significant "captive" raw material resources, which means it internally sources half of its own iron ore needs, half its coal and 80% of its coke.
It is currently increasing its integration with a large iron-ore development project in Liberia and mine expansions in Kazakhstan, Bosnia and Mexico, according to Altman.
Founder Lakshmi Mittal and his family continue to control the company even after its merger with Luxembourg-based Arclor and occupy most of the key management positions.
It’s nice work if you can get it. And, of course, there are the usual problems with a commodity producer, which is subject to the vagaries of steel prices (which are currently in recovery mode) and the questionable strength of the global economy.
But considering that China… >
continues to put up 9%+ growth, including a 25%+ jump in auto production, the world appetite for steel may be its least worrisome problem. As the global industry has consolidated, producers have closed plants and kept prices from slipping.
I think Mittal deserves a higher multiple than Brazilian, Korean, American and European steelmakers. Despite its size, Mittal still has a lot of opportunities ahead, including forays into Latin America, India and deeper into China via joint ventures.
Lately, Mittal has been busy acquiring more raw materials such as iron ore, metallurgical coal and scrap steel. The cost to produce coke can now cost as much as $250 a ton, compared to $90 last year. To deal with the increasing demand and relatively low supply of raw materials, MT has also hiked its prices. It has boosted prices paid to the auto industry by 60% and hiked its flat carbon steel prices by 7%.
The company has targeted the Appalachians for a couple of its acquisitions. MT has agreed to acquire Concept Group, which owns about 57 million tons of coal reserves in West Virginia; it’s a type of coal that’s ideal for coke furnaces. That followed a June 23rd announcement to acquire the Mid Vol Coal Group, which is also in West Virginia. It produced 1.5 million tons of metallurgical coal in 2007 and has more than 85 million tons of reserves. MT liked their proximity as well as their production capacity.
After a failed attempt to acquire Macarthur, an Australian coal supplier, of which it already owns part, MT instead purchased an additional 5% of the company for $204 million. Macarthur supplies more than a third of the world’s pulverized coal. MT’s stake in Macarthur is now 20%.
MT’s steel competitors around the world are scrambling to join in on the acquisitions. Cleveland-Cliffs (CLF), an iron ore miner, acquired a West Virginia and Alabama operator last year and two weeks ago bid about $10 billion for Alpha Natural Resources (ANR) of Virginia.
BHP Billiton (BHP), an international mining conglomerate, is attempting a $170 billion acquisition of Rio Tinto in London. Posco (PKX), a Korean steel company, bought 10% of Macarthur Coal.
In its fiscal second quarter, MT earned $4.19 a share, which was a whopping $1.38 better than the consensus estimate of $2.81. Revenues jumped 39% year over year to $37.8 billion, which beat the $35 billion consensus. Shares are still cheap, so the stock is a great buy on dips.
For another great play on steel, check out Trader’s Advantage; our latest pick in the industry is already up 8% in the past couple of days since picked, and has a lot further to go.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights like this, visit www.InvestorPlace.com.
