Jeremy Glaser: For Morningstar I'm Jeremy Glaser. I am here today with Bridget Freas. She is an Equity Analyst at Morningstar and we're going to take a look at her three thoughts on ArcelorMittal.
Bridget, thanks for joining me today.
Bridget Freas: Thank you.
Glaser: So Arcelor just reported earnings. Can you talk to us a little bit about what their earnings report showed and what their outlook for the future is?
Freas: Sure. Well, as we expected, they reported a pretty rough fourth quarter which has been the case across the board with most steelmakers. Input costs were really high, especially towards the end of 2010 and that really created some margin compression. But they had a very bullish outlook, particularly for the first half of the year.
We've seen steel prices come up 50% or more, particularly in the U.S. in the recent weeks. They guided to much better capacity utilization for the first quarter which is an indication of end market demand improving. They said they expect steel consumption to increase 7% overall for 2011. But they were very cautious on any guidance for the latter half of the year, which we actually think is a positive for the stock because there is a lot of uncertainly in the market right now.
The way we've seen steel price cycles shorten, raw material costs volatility, end market demand has been spotty at best, so I think there is something weighing down the stock related to a lot of uncertainty in the latter half of the year. But we actually think that ArcelorMittal is one of the better positioned companies to perform in that type of environment.
Basically that's speaks to their geographic and end market diversification, their raw material flexibility, which is the use of scrap metal and iron ore and coking coal for their steelmaking and their captive raw materials sources, they are expecting to increase their own iron ore production by 10% in 2011.
Glaser: One of their big pushes into having more iron ore production was taking a big stake in a Canadian mining firm. Can you talk a little bit about that mine and if you think that's going to impact the business at all?
Freas: Sure. Yes. This is definitely another thing that I think is a positive for the Company, especially over the long-term. As I mentioned raw material costs have gone up tremendously. This has been a big concern for the company. They have definitely stressed their need to source more raw material internally.
So this is a major acquisition that they are making. It's the Baffinland Iron Mines Corporation up in the Arctic Circle in Canada. It's primary asset is the Mary River deposit, which is a very early-stage project, so the feasibility studies are still being conducted. So there is certainly a lot of risk here, but this is one of the highest grade undeveloped iron ore projects.
It's in a relatively low-risk jurisdiction being in Canada. The expected operating costs thus far are quite low but the main thing is the price is very attractive. If you compare this to other recent iron ore mine acquisitions, they are getting a very, very good price here. I think the reason for that is because there are these few companies that could have done this deal. The acquisition to develop the mine is going to cost $5 billion in capital expenditures in the next several years, very few companies would have the deep pockets to fund that.
I think the lack of reasonable buyers kept the price low and also there is some execution risk. This is up in the Arctic Circle, its frozen ground, there is going to be some need for transportation infrastructure, but again I think ArcelorMittal is very well positioned to execute well. They have a lot of experience in iron ore mining. They own two mines in Canada already. They also have mining operations in Liberia and Kazakhstan. So there are some challenges ahead, but I think in the end this is a great transaction for the Company.
Glaser: What's your view of the Company spinning off their stainless steel unit?
Freas: Yeah. So just in the last couple of weeks they decided to spin that off into a separate company, it's been rebranded and I think this a good thing. Stainless was a small part of their business, it was only about 10% of their total steelmaking capacity. And there really isn't a lot of synergies between carbon steel and stainless steel. I think there was probably some cost cutting that could have been done on the stainless side that management just wasn't focused on. So getting that removed from the business, having its own management team could probably be better able to clean that up.
Also, stainless steel is more linked to consumer needs rather than construction and things like that, so it's more of a later stage growth. If you look at where ArcelorMittal's customers are, they are operating increasingly in emerging markets where the demand for stainless steel is going to be much later, so it's not really a near-term growth story for them. And then also we have some concerns that there might be some overcapacity in stainless, particularly in Europe. So, I think spinning that off might be setting it up for perhaps being consolidated or acquired by another stainless producer which I think will be beneficial to the market overall.
Glaser: Finally, what are your views on the valuation of their shares right now?
Freas: So my fair value estimate on the stock is $52. I think right now it's trading at $38, so that's a four star. So I think it is slightly undervalued. It's about a seven times multiple on my 2012 EBITDA estimates, so it's pretty attractive right now.
Glaser: Bridget, thanks so much for joining me today.
Freas: Thank you.
Glaser: For Morningstar I'm Jeremy Glaser.