Analyst Note 11-10-2005
Mittal's MT third-quarter earnings, released Nov. 9, echoed those of pretty much every other steelmaker in the world. The message is that 2005 is not going to be as good as 2004, but it's still going to be a pretty good year.
Mittal was not immune to the steel industry's tough third quarter. Prices dropped because of an inventory overhang in the Western markets and a slowdown in Chinese consumption. Costs rose as energy prices soared and raw-material producers extracted cost increases. The double-whammy of falling prices and rising costs led to a precipitous 60% drop in operating profit from third-quarter 2004 levels.
Though a 60% drop in earnings is not something to ignore, we're not pushing the panic button just yet. Ignoring the unrealistic comparison to the third quarter of 2004 (the greatest quarter in steelmaking history), Mittal produced some pretty strong numbers despite significant headwinds. The company's operating margin held at 11%, and it generated over $600 million of free cash flow for the quarter. In fact, Mittal's performance this quarter is very much in line with what we believe are conservative long-term operating assumptions. Finally, indications show that the excess inventories in the market have been worked off, underlying demand is still strong, and that steel prices and volumes are beginning to rise.
Aside from earnings news, the quarter was busy for Mittal. The company signed a new labor agreement with the workers at it's North American Inland-Ispat subsidiary. This new deal is similar to the one brokered by Wilbur Ross at ISG and brings all of Mittal's North American labor under the same progressive contract. The company also bought a 37% stake in Chinese steel producer Hunan Valin, marking the firm's first expansion into the all-important Chinese market. Finally, as described in our last Analyst Note, Mittal purchased Ukrainian steel and iron ore producer KryvorizhStal for $4.8 billion.
Thesis 09-26-2005
Mittal Steel's global presence, market position, and vertical integration have firmly established it as the leader of the consolidating steel industry and have earned the company a narrow moat.
Mittal dwarfs its rivals in size and global diversification, boasting production capacity that is nearly 3 times U.S. Steel's X. With operations that span the globe, it is the largest steel producer in North America and the second largest in Europe. And as the only truly global steel producer, Mittal is uniquely positioned to read and respond to changing market demands and to provide a supply solution to an increasingly global base of manufacturers.
A leader of the industrywide consolidation trend, Mittal has excelled at selectively buying underperforming assets at a discount and rapidly turning the businesses around. Whether it's a steel mill in Kazakhstan that was operating on a barter system or old-line U.S. mills bound in a vicious cycle of bankruptcies (like Bethlehem or Inland), Mittal's management has been successful in restoring profitability to these enterprises. Although 2004 was a banner year for steel in general, Mittal's 30% pro forma return on invested capital ranked as one of the highest in the industry.
Consolidation has had a stabilizing effect on the steel world. Production in the most fragile markets--the U.S. and Europe--has become concentrated in the hands of a few large players. During the most recent downturn in steel prices (mid-2005), the major players were able to trim production quickly and managed to avoid an outright collapse in the steel market.
Improved markets in North America and Europe are just part of the story, as Mittal's best assets are its operations in Asia, Africa, and Central and Eastern Europe. Formed mostly from privatized government ventures, these mills have averaged operating margins in excess of 30% for the past four years. Accounting for approximately 40% of total production on a pro forma basis, these mills have significant advantages in terms of labor costs, energy costs, and captive raw-material sources.
As a whole, Mittal enjoys a raw-material self-sufficiency that should help insulate it from the volatility of iron and coal prices. The balance sheet is also in excellent condition, with $2.0 billion of net debt and fully funded pensions.
Steel is always a tricky area of the market, but we think Mittal has made all the right moves to qualify as a viable long-term investment if purchased at an appropriate discount to our fair value estimate.
Valuation
Our fair value estimate for Mittal is $39 per share. We've modeled the company on a pro forma basis for the ISG acquisition. On this basis, we expect only marginal revenue growth for 2005 and operating margins to contract from 22% to around 19% for the year. We expect the decrease in production and margins that began in 2005 to continue into 2006. We are not predicting a collapse, but we think that 2004's levels were an anomaly and are not sustainable. Long term, we have taken a conservative approach with Mittal's Americas and European groups and expect them to make an average operating profit of $25 per ton produced. We expect the more resilient Asia and Africa group to be able to generate an average operating profit of around $100 per ton produced. We also assume that capital expenditures will average around 4% of sales over the long term.
Risk
Mittal is still working to integrate several of its acquisitions. ISG, the company's most recent acquisition, was itself an integration work in progress and will most likely present the most challenges. Although globally diversified, pockets of weakness will pop up from time to time. Right now, weakness in the U.S. automotive sector is our largest concern. Finally, a slowdown in the Chinese economy could flood the market with steel until production can be rationalized.
See Previous Analyst Reports
Close Competitors TTM Sales $Mil Market Cap $Mil
Mittal Steel Co NV 22,197 18,795
* United States Steel 14,592 5,851
* AK Steel Holding 5,704 873
* Posco ADR 20,855 16,553
* Gerdau SA ADR PN 6,952 8,118
* Nucor 12,583 11,267
* Morningstar Analyst Report Available | Compare These Stocks
Data as of 12-31-2004
Strategy
Mittal is the largest participant in the consolidation of the steel industry. We expect the company to continue seeking acquisitions and investments that will expand its geographic footprint and raw-material capabilities. In addition to acquisitions, we expect the company to rationalize production assets, spend on efficiency projects, and leverage knowledge across its platform.
Management & Stewardship
Mittal is owned and managed by Lakshmi Mittal and his family. The Mittal family has become quite famous lately after Lakshmi vaulted to number three on the Forbes billionaire list, one spot behind Warren Buffett. The Mittals' control of over 75% of the outstanding stock as well as most of the supervoting Class B shares means minority holders will have little say for the foreseeable future. The father-son duo of Lakshmi and Aditya Mittal occupies the top of the corporate structure and have been the driving force behind Mittal Steel's acquisition and turnaround efforts. Outside of the Mittal family, the company's management team boasts an impressive staff of experienced steel managers as well as operations and financial experts from outside the industry. Financier Wilbur Ross occupies a seat on the board and reinvested a large portion of his ISG holdings with Mittal. We take comfort in the fact that a savvy investor such as Ross was inclined to keep his steel investment instead of cashing out.
Profile
Mittal Steel is the world's largest steel producer. The company produces steel in 14 countries and has the capacity to produce more than 58 million tons of steel annually. Mittal also operates several iron mines, coal mines, and coke plants. The company produces a mixture of both long and flat steel and operates both integrated and mini-mill operations.
Growth
Mittal has experienced tremendous growth over the past few years fueled by acquisitions and a rebound in steel prices. We expect acquisitions to continue to be the main catalyst for growth, although efficiency improvements will also contribute.
Profitability
Although 2004 was an incredibly profitable year, we consider it an anomaly. We expect the company's Asia and Africa operations to provide steady profits to offset the volatility of the other markets.
Financial Health
Mittal has an investment-grade credit rating and historically strong cash flows. The company has a net debt position of $2.0 billion and fully funded pensions.
Morningstar Rating
01-23-2006
Stock Price
As of 11-10-2005
$24.70
Fair Value Estimate
$39.00
Consider Buying
$30.10
Consider Selling
$48.90
Business Risk
Avg
Economic Moat
Narrow
Just put in a limit order at $30 a share
Mittal's MT third-quarter earnings, released Nov. 9, echoed those of pretty much every other steelmaker in the world. The message is that 2005 is not going to be as good as 2004, but it's still going to be a pretty good year.
Mittal was not immune to the steel industry's tough third quarter. Prices dropped because of an inventory overhang in the Western markets and a slowdown in Chinese consumption. Costs rose as energy prices soared and raw-material producers extracted cost increases. The double-whammy of falling prices and rising costs led to a precipitous 60% drop in operating profit from third-quarter 2004 levels.
Though a 60% drop in earnings is not something to ignore, we're not pushing the panic button just yet. Ignoring the unrealistic comparison to the third quarter of 2004 (the greatest quarter in steelmaking history), Mittal produced some pretty strong numbers despite significant headwinds. The company's operating margin held at 11%, and it generated over $600 million of free cash flow for the quarter. In fact, Mittal's performance this quarter is very much in line with what we believe are conservative long-term operating assumptions. Finally, indications show that the excess inventories in the market have been worked off, underlying demand is still strong, and that steel prices and volumes are beginning to rise.
Aside from earnings news, the quarter was busy for Mittal. The company signed a new labor agreement with the workers at it's North American Inland-Ispat subsidiary. This new deal is similar to the one brokered by Wilbur Ross at ISG and brings all of Mittal's North American labor under the same progressive contract. The company also bought a 37% stake in Chinese steel producer Hunan Valin, marking the firm's first expansion into the all-important Chinese market. Finally, as described in our last Analyst Note, Mittal purchased Ukrainian steel and iron ore producer KryvorizhStal for $4.8 billion.
Thesis 09-26-2005
Mittal Steel's global presence, market position, and vertical integration have firmly established it as the leader of the consolidating steel industry and have earned the company a narrow moat.
Mittal dwarfs its rivals in size and global diversification, boasting production capacity that is nearly 3 times U.S. Steel's X. With operations that span the globe, it is the largest steel producer in North America and the second largest in Europe. And as the only truly global steel producer, Mittal is uniquely positioned to read and respond to changing market demands and to provide a supply solution to an increasingly global base of manufacturers.
A leader of the industrywide consolidation trend, Mittal has excelled at selectively buying underperforming assets at a discount and rapidly turning the businesses around. Whether it's a steel mill in Kazakhstan that was operating on a barter system or old-line U.S. mills bound in a vicious cycle of bankruptcies (like Bethlehem or Inland), Mittal's management has been successful in restoring profitability to these enterprises. Although 2004 was a banner year for steel in general, Mittal's 30% pro forma return on invested capital ranked as one of the highest in the industry.
Consolidation has had a stabilizing effect on the steel world. Production in the most fragile markets--the U.S. and Europe--has become concentrated in the hands of a few large players. During the most recent downturn in steel prices (mid-2005), the major players were able to trim production quickly and managed to avoid an outright collapse in the steel market.
Improved markets in North America and Europe are just part of the story, as Mittal's best assets are its operations in Asia, Africa, and Central and Eastern Europe. Formed mostly from privatized government ventures, these mills have averaged operating margins in excess of 30% for the past four years. Accounting for approximately 40% of total production on a pro forma basis, these mills have significant advantages in terms of labor costs, energy costs, and captive raw-material sources.
As a whole, Mittal enjoys a raw-material self-sufficiency that should help insulate it from the volatility of iron and coal prices. The balance sheet is also in excellent condition, with $2.0 billion of net debt and fully funded pensions.
Steel is always a tricky area of the market, but we think Mittal has made all the right moves to qualify as a viable long-term investment if purchased at an appropriate discount to our fair value estimate.
Valuation
Our fair value estimate for Mittal is $39 per share. We've modeled the company on a pro forma basis for the ISG acquisition. On this basis, we expect only marginal revenue growth for 2005 and operating margins to contract from 22% to around 19% for the year. We expect the decrease in production and margins that began in 2005 to continue into 2006. We are not predicting a collapse, but we think that 2004's levels were an anomaly and are not sustainable. Long term, we have taken a conservative approach with Mittal's Americas and European groups and expect them to make an average operating profit of $25 per ton produced. We expect the more resilient Asia and Africa group to be able to generate an average operating profit of around $100 per ton produced. We also assume that capital expenditures will average around 4% of sales over the long term.
Risk
Mittal is still working to integrate several of its acquisitions. ISG, the company's most recent acquisition, was itself an integration work in progress and will most likely present the most challenges. Although globally diversified, pockets of weakness will pop up from time to time. Right now, weakness in the U.S. automotive sector is our largest concern. Finally, a slowdown in the Chinese economy could flood the market with steel until production can be rationalized.
See Previous Analyst Reports
Close Competitors TTM Sales $Mil Market Cap $Mil
Mittal Steel Co NV 22,197 18,795
* United States Steel 14,592 5,851
* AK Steel Holding 5,704 873
* Posco ADR 20,855 16,553
* Gerdau SA ADR PN 6,952 8,118
* Nucor 12,583 11,267
* Morningstar Analyst Report Available | Compare These Stocks
Data as of 12-31-2004
Strategy
Mittal is the largest participant in the consolidation of the steel industry. We expect the company to continue seeking acquisitions and investments that will expand its geographic footprint and raw-material capabilities. In addition to acquisitions, we expect the company to rationalize production assets, spend on efficiency projects, and leverage knowledge across its platform.
Management & Stewardship
Mittal is owned and managed by Lakshmi Mittal and his family. The Mittal family has become quite famous lately after Lakshmi vaulted to number three on the Forbes billionaire list, one spot behind Warren Buffett. The Mittals' control of over 75% of the outstanding stock as well as most of the supervoting Class B shares means minority holders will have little say for the foreseeable future. The father-son duo of Lakshmi and Aditya Mittal occupies the top of the corporate structure and have been the driving force behind Mittal Steel's acquisition and turnaround efforts. Outside of the Mittal family, the company's management team boasts an impressive staff of experienced steel managers as well as operations and financial experts from outside the industry. Financier Wilbur Ross occupies a seat on the board and reinvested a large portion of his ISG holdings with Mittal. We take comfort in the fact that a savvy investor such as Ross was inclined to keep his steel investment instead of cashing out.
Profile
Mittal Steel is the world's largest steel producer. The company produces steel in 14 countries and has the capacity to produce more than 58 million tons of steel annually. Mittal also operates several iron mines, coal mines, and coke plants. The company produces a mixture of both long and flat steel and operates both integrated and mini-mill operations.
Growth
Mittal has experienced tremendous growth over the past few years fueled by acquisitions and a rebound in steel prices. We expect acquisitions to continue to be the main catalyst for growth, although efficiency improvements will also contribute.
Profitability
Although 2004 was an incredibly profitable year, we consider it an anomaly. We expect the company's Asia and Africa operations to provide steady profits to offset the volatility of the other markets.
Financial Health
Mittal has an investment-grade credit rating and historically strong cash flows. The company has a net debt position of $2.0 billion and fully funded pensions.
Morningstar Rating
01-23-2006
Stock Price
As of 11-10-2005
$24.70
Fair Value Estimate
$39.00
Consider Buying
$30.10
Consider Selling
$48.90
Business Risk
Avg
Economic Moat
Narrow
Just put in a limit order at $30 a share
