Despite some of the positive rhetoric surrounding ArcelorMittal, the fact remains that the company has significant exposure to Europe. The steelmaker is practically a European company. The whole region is witnessing soft demand and prices are expected to remain under pressure in the near future as, according to Eurofer, the continent’s steel industry’s lobby group, the capacity exceeds the supply by 50-60 million metric tons. Furthermore, rising energy prices and labor costs are hurting Europe’s heavy industries, which I believe is one of the main reasons behind the soft steel demand from the continent.
ArcelorMittal is expecting a low to mid-single digit growth in demand in each of its markets except Europe, where it expects a decline. This year, global steel demand could grow by 3% to 3.5% while Europe will contract by 1%. Investors should note that Europe’s anticipated contraction is considerably better from last year’s decline of 9%.
However, things are much better in the U.S and China. Both these regions could witness an increase in demand of 3% to 4.5%. Despite the current slowdown in the U.S., the automotive sector in both these countries has been showing improvements. According to Lakshmi Mittal, ArcelorMittal’s CEO, American auto sales could cross 15 million units this year. But the downside is that problems associated with overcapacity coming from China will persist in the near term.
China alone accounts for 46% of the total global production, and overcapacity from here puts pressure on steel prices around the world in general and Europe in particular. This year’s overcapacity is expected to be around 200 million tons. Therefore, China will continue to exert downward pressure on steel prices.
What this means for ArcelorMittal’s investors is that they have little option but to ride out this tough environment as the company continues with its cost cutting initiatives and focuses more toward more lucrative operations – such as the new high-margin steel products for the energy and automotive sectors.
I believe that things will significantly change for the better for steel stocks in general and ArcelorMittal in particular once Europe stops contracting and China starts growing. However, that is not going to happen in the short-term which is evident from China’s anticipated overcapacity.
For now, United States Steel Corporation (NYSE:X) looks better simply because it is not heavily exposed to Europe and is better positioned to gain from the improving market conditions at home. Although U.S. Steel is considered one of the most expensive stocks with a lofty price-to-earnings ratio of 122.30 but what makes it relatively more valuable is its lower enterprise value, or EV, to sales ratio.
The EV to sales ratio gives better valuation as compared to P/E ratio when an industry, like steel, is cyclical in nature. Moreover, unlike the market cap, EV incorporates the effects of debt and cash reserves. In this case, ArcelorMittal’s EV to sales ratio is 0.49 while U.S. Steel’s is 0.31, which makes it more valuable.
Sarfaraz Khan has no position in any stocks mentioned. The Motley Fool recommends Nucor. The Motley Fool owns shares of ArcelorMittal.
The article This Steel Giant Is Expecting an Improved Business Environment originally appeared on Fool.com.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
