Low labor and raw material costs provide Brazil’s foundries and metal producers with an advantage over worldwide competitors. Furthermore, several international sports events coming up in the next three years will certainly boost the demand for metals, as huge infrastructural projects are undertaken by the state. The Brazilian Steel Institute expects sales to increase by 7.7% in 2013. Three companies in particular, Gerdau SA (ADR) (NYSE:GGB), Vale SA (ADR) (NYSE:VALE) and Companhia Siderurgica Nacional (ADR) (NYSE:SID), deserve a closer look, as their upside potential is substantial.
A market leader
Not only is Gerdau SA (ADR) (NYSE:GGB) a leader for steel production in Brazil, but also the second largest in the world. It operates 59 production units, both locally and overseas, in other South American countries as well as in North America, Europe, and Asia, and has a history of over 100 years of consistent profitability. Geographically diversified, the company can stand weak domestic demand levels, as international exposure has tended to balance this trend.
Its model is quite interesting: the company uses mini-mills to process scrap metal, turning it into steel. This helps it face the cyclicality of the industry by reducing costs and operating leverage (Morningstar).
Furthermore, the firm counts with a high level of vertical integration and owns a stake in iron ore mines and distribution, coke production, and scrap recycling. This reduces both its raw material costs and its dependence on third party providers. Moreover, according to Zacks analysts, iron ore mines are expected to produce 11.5 million tons in 2013 and reach 18 million tons in 2016.
Trading at only 6.5 times its earnings while expecting an average annual growth of almost 12% for the five upcoming years, about ten times its peers’ mean, I would advocate buying this stock. Even despite its volatility (beta is 1.94), I believe that the current is a good entry point for a company that is poised to grow in the years to come.
A good pick
Unlike other big diversified miners, Vale SA (ADR) (NYSE:VALE) focuses on iron ore production, which accounts for 70% of sales and 90% of EBITDA. Although this has made the firm widely dependent on the segment, it has also provided it with the most valuable iron ore franchise in world, producing about 20% more volume than its closest competitor, Australia’s Rio Tinto, and almost double the third-runner, BHP Billiton (Morningstar). Nevertheless, its subsidiary businesses are not to be under-appreciated; its mining segment is important and has registered considerable volume growth, especially in the coal production. Last quarter, the firm reported an increase of 17% year-over-year in its coal production levels. Its logistics are also to be highlighted: its integrated railroad and marine terminal system saves plenty of money for the firm and, in addition, generates about 7% of the firm’s total revenue.
Just like Gerdau SA (ADR) (NYSE:GGB), Vale SA (ADR) (NYSE:VALE) enjoys lower costs than most of its peers. As such, it is better positioned to face the cyclical and volatile nature of the industry, as well as to benefit from the expansion of global steel demand, expected at 3.2% for 2013 (World Steel Association), and the local steel demand, which should experience momentum as the World Cup and the Olympics get closer. Furthermore, expanding demand of steel in emerging markets like India, China, and Southeast Asia should drive growth in the years to come.
Several cost-reduction initiatives should take earnings figures even higher. Last quarter, the company reported a 27% decline in expenses relative to the previous quarter, and will continue to save money by selling off its less-profitable assets.
Vale SA (ADR) (NYSE:VALE) is trading at only 16.5 times its earnings, versus the 172.4 times industry mean, while offering a projected dividend yield of 4.78% and an EPS growth rate expected at 13% annually over the next five years. I’d recommend buying and holding this stock, as upside potential is bound to come.
Companhia Siderurgica Nacional: A company to keep an eye on
After a very weak first quarter, Companhia Siderurgica Nacional (ADR) (NYSE:SID)‘s stock price is close to its 10-year low, trading at only $3.38 per share. Despite its low pricing, several concerns about future profitability remain, mainly due to the cyclicality of the industry, the risks associated with the ongoing diversification of activities at Companhia Siderurgica Nacional (ADR) (NYSE:SID), and the political and currency volatility in Brazil. Although I would advocate holding for now, especially as the two aforementioned companies offer clearer outlooks, I would also recommend not losing track of this firm’s activities and stock, as upside is not at all unlikely.
One of the main reasons to believe that this company will deliver strong results in the years to come is the increasing demand for steel, both locally and globally. Furthermore, Companhia Siderurgica Nacional (ADR) (NYSE:SID) has been reducing its dependence on steel production by entering other segments, like mining, which accounted for approximately 26% of 2012’s total revenue. Several investments are to be made soon in order to increase production capacity. For 2013, capex allocated for expansion plans will be roughly $1 billion (about R$2.2 billion).
Moreover, the company has managed to reduce the competition it faces while expanding its margins by high value-added steel products.
Apart from organic growth, acquisitions have driven expansion in the past and will most likely continue to do so. Some important recent ventures include mills in Indiana, Portugal, and Germany. In addition, vertical investments in mining, electricity, and transportation will reduce costs, thus driving profit even further.
Even in spite of its ill-looking financial figures, Companhia Siderurgica Nacional (ADR) (NYSE:SID) deserves your attention. As its balance sheet improves, more alluring entry points should show up and you wouldn’t want to miss them, especially with its stock priced so low.
Bottom line
Although Vale SA (ADR) (NYSE:VALE) trades at higher P/E values than Gerdau SA (ADR) (NYSE:GGB), it also offers a lower beta ratio and slightly higher consensus estimate growth rates. However, both provide plenty of upside potential for investors and are, therefore, interesting long-term investments. Companhia Siderurgica Nacional (ADR) (NYSE:SID) is a hold for now, but I advocate not losing sight of this company, as upside potential could appear any time soon and you might want to catch it before the stock price starts rising.
The article Invest In These 3 Brazilian Steel Companies originally appeared on Fool.com and is written by Damian Illia.
Damian Illia has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Damian is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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