ArcelorMittal Has Continued To Skid On Cycle And Capital Allocation Worries
Dec. 5, 2018 11:07 AM ET
Summary
Steel spreads have come under serious pressure, particularly for blast furnace operators, and both pricing and demand growth seem to be fading.
ArcelorMittal continues to deploy capital toward expanding its operations, including the acquisitions of Ilva and Essar, and meaningful additional distributions to shareholders could be years away.
The market is definitely down on steel; ArcelorMittal's valuation seems too low by historical norms, but it's hard for steel stocks to outperform when prices, spreads, and profits are squeezed.
Some of the best spreads in recent memory haven’t been much help to the steel sector over the past year, and now it looks like the cycle is meaningfully slowing down. With steel prices declining around the globe, apparent demand softening, and growing worries about expanding capacity, coupled with shrinking spreads and sell-side forecasts for declining EBITDA, it doesn’t look like a particularly healthy set-up for ArcelorMittal (MT).
I wasn’t bullish on ArcelorMittal back in September, even though the shares “looked cheap” by multiple metrics, and the shares have fallen nearly another 30% since then. I still can’t really bring myself to want to own these shares myself, even though once again the valuation seems harsh by most metrics I can evaluate.
Shrinking Spreads And Fading Demand?
Steel prices are obviously important to profits, but they’re only part of the equation. The cost of inputs also looms large in steel spreads, and ArcelorMittal is starting to face some challenging conditions. In the EU, spreads have fallen sharply over the last six months, with Morgan Stanley recently highlighting a move from a well-above-average level of around $350/mt to around $270/mt more recently (still about 10% above the long-term average). That shrinkage was at least partly visible in ArcelorMittal’s recent earnings report, as EBITDA in the European business shrank 24% qoq on a reported basis and about 17% on a per-tonne basis to just $90 (about one-third to 40% lower than the spreads in the NAFTA, Brazil, and ACIS units).
There have also been signs of weakening spreads in ArcelorMittal’s key NAFTA business. While U.S. steel prices have remained stronger than in Europe, and electric arc spreads are still quite healthy for companies like Steel Dynamics (STLD) and Nucor (NUE), ArcelorMittal has seen weaker volumes in North America and blast furnace spreads have shrunk significantly since the middle of the year.
Given recent commentary from steel company executives at sell-side conferences as well as third-party research surveys, it does look like demand growth is moderating. The World Steel Association is forecasting just over 1% growth in world steel demand in 2019 after nearly 4% growth in 2018, and several companies have noted signs of slowing demand in both North America and the EU. It is worth mentioning that the outlook is still for positive demand growth, and coupled with rising capacity utilization that should offer some support for pricing, but the market doesn’t seem set up for the “rising prices, rising demand” couplet that investors typically want to see. Along those lines, prices for hot-rolled steel have continued to decline in recent months in both Europe and the U.S., with the U.S. starting to catch up to earlier declines in Europe.
China likewise remains a wild card. China’s steel industry has curtailed about 20% of its capacity over the past few years, and between environmental concerns, trade disputes, and recent weakness in China industrial and construction demand, it may well be reasonable to think that a lot of that capacity will remain sidelined. Still, depending upon supply-side restraint from China has never been a particularly successful strategy for commodity investors and I remain skeptical.
Investing At The Top?
One of the more controversial parts of the ArcelorMittal story has been management’s ongoing willingness to engage in M&A. Not only would many investors prefer to see management focus on net debt reduction and capital returns to shareholders, there’s a growing concern regarding capacity restarts and additions across the sector.
I understand why the market was rattled by the recent announcement from Steel Dynamics that it intends to start work on a new 3Mtpa plant in 2020 – typically these announcements come at or near the peak of the cycle. Likewise, it looks like 2019 capex spending across the sector will exceed the prior recent peak in 2011. Even if some of this is catch-up spending, it’s not the news an already-nervous market wants to see.