An undervalued play on global growth

This steelmaker trades at just 5.5 times earnings and yields nearly 4%.

By TheStockAdvisors Oct 24, 2011 12:48PM
By Nathan Slaughter, Scarcity & Wealth

The best time to bet on steel is usually at the point of maximum pessimism. I don't know if we're there yet, but it says a lot that ArcelorMittal (MT) recently sank even lower than the depths of the March 2009 bottom.

That spells opportunity, because the company is in much better shape than it was during those dark days.

From 2009 through 2010, ArcelorMittal staged a dramatic recovery, boosting sales by $17 billion and turning a huge bottom-line loss into a comfortable $3.6 billion profit.

And through the first half of 2011, revenue and earnings are both tracking far ahead of last year's pace at 26% and 69%, respectively.

Business isn't back to full strength, but it has come a long way. And the market responded to that progress on the ground, pushing MT from below $20 to a peak near $50.

But now, in less than three months, the shares have relinquished that advance. The stock is now trading at just 5.5 times earnings, and that's with profits running at less than half their former peak.

The company has production facilities in Mexico, Poland, South Africa and about 20 other countries.

That global footprint provides several competitive advantages. Having plants close to regional customers minimizes shipping costs and enables the company to tailor its product line to meet demand.

ArcelorMittal has invested billions over the years to buy its own coal mining and iron ore assets. The latest acquisition, announced in July, is a takeover bid for Australia's Macarthur Coal.

That vertical integration cuts the middleman out of the equation and means that ArcelorMittal is largely self-sufficient when it comes to securing these critical inputs.

In turn, these mining assets reduce volatile raw-materials costs and widen profit margins. What the company doesn't use internally is sold to generate even more income.

ArcelorMittal also has the inside track to lock up sales in faster-growing emerging countries. The company has worked hard to penetrate attractive markets from Brazil to Kazakhstan, and the developing world now accounts for a third of the company's product shipments.

About 38,000 vehicles are rolling out of Chinese factories each day. The country also has ambitious plans to start construction on a new skyscraper every five days over the next three years.

That's a lot of steel plates, and a lot of rebar and beam. And we're seeing similar industrialization in India and many other places.

Much of that demand will fall to ArcelorMittal, which controls a dominant 20% share of the worldwide automotive steel market, along with leading positions in engineering/construction, appliances, energy, and most other major applications.

Investors are currently preoccupied with the economic slump in Europe and North America, as well as potential signs of deceleration in China. These are valid concerns.

But the shares are already priced for a more severe slowdown than what we saw in the last recession. And while there are headwinds, I don't think we're headed for a repeat. That's not to say the stock can't drop further, but most of the air has already been let out.

Current fears are masking the firm's true value. This is a company that, under normal market conditions, churns out nearly $24 billion in earnings (EBITDA) and over $100 billion in revenue.

Pound for pound, that's some heavy lifting for a company whose market capitalization is just $27 billion.

I'm not too worried about a potential downturn in steel consumption (these cyclical slumps are normal and temporary).

At the end of the day, steel is the very foundation of global economic activity. Whether it's wind turbines, home appliances, or miles of oil/gas pipeline, you can't grow without steel.

ArcelorMittal will be right in the middle of the action. And with just 8% of the fragmented global market, it has plenty of opportunity for further consolidation.

As an added bonus, the pullback has given investors a chance to lock in a healthy 4% dividend yield.

But that's nothing compared to possible 50%-plus capital gains as the shares potentially work their way back into the upper-$20s over the next 18 months. Keep in mind, this was a $100 stock before the crash.

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