Gerdau soars on growth expectations

The stock flies high above the otherwise stagnant Brazilian steel industry. So is it time to buy?

By Jim J. Jubak Jan 26, 2012 3:46PM
Image: Brazil (© Donald Edwards/age fotostock)The numbers out of Brazil's steel industry are ugly. How ugly? Uglier than a mole rat. Uglier than the first day of school. Uglier than an Ugli fruit.

Brazil's steel industry produced a record 35.2 million metric tons in 2011, 6.8% more than in 2010, but "apparent consumption" (the sum of domestic production plus imports minus exports) fell by 4.2% to just 25 million tons. And since Brazil’s steel industry has a total capacity of 45 million tons, steel prices haven't gone up strongly even if exports did climb 21% in 2011.

In short, there's nothing in the current picture of the Brazilian steel industry to explain why the American Depositary Receipts (ADRs) of Gerdau (GGB) are up 35.9% from Dec. 19. (Gerdau is a member of my 12-18 month Jubak's Picks portfolio.)

Part of that jump is due, of course, to the switch from risk-off to risk-on that has swept the entire global market in the last month. Traders and investors have decided, apparently, that the European Central Bank has poured enough money into European banks, that the U.S. economy is growing modestly, and that neither China nor Brazil are headed to a hard landing, so it's okay to move money from safe havens such as U.S. Treasuries to global equities. In the same period that produced Gerdau’s 36% gain, the iShares MSCI Brazil Index ETF (EWZ) rose 13%.

But that's only part of the story -- since Gerdau has outperformed the ETF (exchange-traded fund) so massively.

For the rest, you have to look to the passage of time -- which has reduced the countdown until growth kicks in for Gerdau on expectations of a Brazilian recovery after years of bad news on growth -- and on steel-specific expectations connected to Brazil hosting the World Cup in 2014 and the Summer Olympics in 2016. 

The expectation, and I think it's accurate given the state of the required infrastructure in Brazil, is that the two events will be produce a huge boom for any company connected to construction projects. And as a company focused on long-steel products such as rebar, boy, oh, boy is Gerdau connected to construction. (It also doesn’t hurt that Gerdau is one of the world’s lowest-cost steel makers.)

You can see that anticipation built into the earnings estimates for Gerdau. Credit Suisse thinks the company earned .88 reais a share in 2011, and will earn 1.71 in 2012 and then 2.22 in 2013. That would drop the price-to-earnings ratio for the underlying Brazilian shares from 17.3 in 2011 to 8.9 in 2012 to 6.8 in 2013.

In June 2011,  I set a target price of $16 a share for Gerdau's ADRs by the end of the year. With Brazil's economy slowing and investors running from risk that sure didn’t happen. The ADRs finished 2011 at $7.81.

But 2012 is not just another year -- it's also a very different year. My end of 2012 target for Gerdau’s ADRs is $16.80 -- although, please note, I don’t expect that ADRs to arrive at that level in one clear run. Expect instead of roller coaster ride to the target.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of Gerdau as of the end of September. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 
Tags: GGB
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