Today the market has been up and sideways basically, perhaps a little more defensive this afternoon,...
Update Gerdau (GGB)
06/30/2011 3:15 pm EST
Shares of other steel-makers were up as well with Nucor (NUE), for example, gaining 4% yesterday and today.
I think it’s the positive change in sentiment toward emerging stock markets that has led to the relative out performance by Gerdau to the steel group. Brazil’s major market index, the Bovespa is up 1.6% from June 24 through 3:00 New York time today, June 30. That’s quite a contrast to the 4.1% loss recorded by the index from June 9 through June 16. And during that period Gerdau has substantially underperformed the market index. In fact, for 2011 to date shares of Gerdau are down 20.63% versus a drop of just 2.81% for the iShares MSCI Brazil Index (EWZ).
So you can see why Gerdau might be bouncing higher than its peers today.
On the fundamentals Gerdau isn’t out of the woods yet, but the forest is thinning. The big problem has been an appreciating Brazilian real that has made steel imports into Brazil cheaper and steel export from Brazil more expensive. (Gerdau exports about 35% to 40% of its Brazilian production.) It doesn’t look like the real is about to get significantly cheaper very soon but I’d expect the rate of appreciation to moderate as the government’s program of interest rate increases to fight inflation draws to a close this year.
Gerdau has had some protection from an appreciating real since the company is also the second largest steel-mini mill operator in North America and gets about one-third of its sales from the United States. Disruptions in the global auto industry after the Japanese earthquake and tsunami have cut into demand and prices in North America—and the recession in the commercial construction industry hasn’t helped—but trends in both areas look better in the second half of 2012.
Margins have already stared to pick up with first quarter EBITDA (earnings before interest, taxes, depreciation, and amortization) margins climbed to 13.2% from 10.4% in the fourth quarter of 2010. That was still below the 19.7% margin in the first quarter of 2010.
One wild card in Gerdau’s valuation is the likelihood that the company will sell off some part of its iron-ore business. Production from its 2.9 billion ton iron ore resource exceeds the future needs of its Acominas mill and the company has scheduled the completion of a study for the end of year on how it could monetize this resources. Credit Suisse estimates that the net present value of Gerdau’s iron ore business is $3.2 billion to $4.2 billion. Gerdau’s total market capitalization is $29 billion.
The battle against inflation in Brazil will continue to operate as a drag on Brazil’s economy and its stock market. The central bank just raised its projections on inflation for the end of 2011 to 5.8%, up from 5.6%. The Banco Central do Brasil also raised its projection for 2012 to 4.8% from 4.6%.
Inflation as of mid-June was running at a 6.55% annual rate. That’s above top end of the bank’s inflation target of 4.5% plus or minus two percentage points.
I think that means the central bank will continue to raise interest rates in order to fight inflation well into the fourth quarter of 2011. That will slow the speed with which Brazilian shares reach their target prices.
I had calculated that Gerdau would reach $20 a share by the end of 2011. As of June 29 I’m cutting my year-end target to $16 a share.
Full disclosure: I do not own shares of any stock mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Gerdau as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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