ArcelorMittal: Macro Risks Weigh Heavily On An Improved Story
Mar. 06, 2022 7:00 AM ET ArcelorMittal S.A. (MT)VLPNY4 Comments
Summary
-ArcelorMittal has temporarily idled its Ukrainian steel operations, and the company's steel and iron operations in Ukraine account for 6%-9% of total EBITDA.
-Ukraine and Russia are major steel suppliers to the EU; lower output could help establish a floor for steel prices, while higher energy prices are pressuring marginal suppliers.
Healthy demand should support pricing in North America and the EU after recent weakness, but margins are still likely to be lower.
-ArcelorMittal shares look undervalued below the low-to-mid-$40s, but there are outsized company-specific risks, and investor sentiment could still be tricky given likely long-term margin declines from 2021 onward.
Headquarters of ArcelorMittal France
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I wasn’t sure I’d ever see a day where steel companies were getting praised as good stewards of capital, ArcelorMittal (MT) in particular, but I suppose given everything that’s happened in the world since 2019, this is further down the list of “things I didn’t think I’d see…” As is, management is doing an excellent job here, with an improved focus on quality over quantity and an eye toward ensuring that shareholders share in more of the upside.
While I do think that many steel stocks have overshot in the cyclical correction and that prices are likely to stabilize relatively soon in the U.S. and Europe, the reality is that sentiment remains a risk as margins are likely to slip further. What’s more, Russia’s invasion of Ukraine creates even more uncertainty for ArcelorMittal given the company’s significant operations in that country.
I was neutral on these shares (and the sector) back in September, and while ArcelorMittal hadn’t done any worse than the average steel stock since until the invasion of Ukraine, the sector has underperformed the broader market. These shares do look undervalued now, but I do also see more long-term risk to sentiment on post-peak margin declines and the situation in Ukraine.
Investors who can afford to be patient (as well as assume the risk of greater steel price corrections and a bad outcome in Ukraine) may well see outsized rewards, but I’m not eager to pursue the elevated risks here even though management is doing a commendable job.
Ukraine Is An Important Part Of ArcelorMittal’s Footprint
ArcelorMittal announced on Thursday (March 3) that it was idling its steelmaking operations at Kryvyi Rih in Ukraine after previously reducing them to “technical minimum” (around one-third normal production) in the interests of protecting its employees. While I have not seen any reports of direct Russian attacks aimed at facilities like steel mills (and Ukraine is a major producer of steel that is exported to the EU), there have reportedly been airstrikes in the Kryvyi Rih region.
ArcelorMittal’s steel operations in the Ukraine (a blast furnace) produce around 6.5% of the company’s total output, and the production here is in long products (rod, merchant bar, et al). The Ukrainian operations also account for about 20% of the company’s iron ore production. All told, ArcelorMittal’s Ukrainian operations likely account for around 6% to 9% of the company’s EBITDA.
This may seem callous in light of the human tragedy in Ukraine at the moment, but the larger impact on the European steel industry is hard to gauge at this point. Ukraine and Russia collectively account for close to a quarter of the EU’s steel imports, and the elimination of that supply could help put a floor under steel prices. On the other hand, the crisis has led to a spike in energy prices, and energy costs were already a notable issue for European steelmakers, including ArcelorMittal and Voestalpine (OTCPK:VLPNY), with some companies electing to cut back production in response to higher costs and weak prospective margins (European production declined 6% year over year in January).
Enjoying The Fruits Of Record Profits
Although steel prices have fallen a fair amount in recent months, with U.S. prices recently about a third below the trailing 12-month average, I believe healthy demand from end-markets like construction and manufacturing across most of ArcelorMittal’s footprint should limit further near-term downward pressure on prices.
With that, while ArcelorMittal won’t enjoy the margins or profits it enjoyed in FY’21, this year (2022) is shaping up to be another year of strong above-trend profitability, with EBITDA margins of around 20% and possibly over 20%. Free cash flow also looks to be quite strong for the year, with working capital movements likely to lead to a new record for 2022.