Is Gerdau Sinking Like a Steel Balloon?

04/02/2012 4:05 pm EST


Jim Jubak

Founder and Editor,

The Brazilian blue chip has remained attractive despite enormous economic pressures, and with those weights lifting, the stock may soon rise like it should have been for some time, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

Brazilian steelmaker Gerdau (GGB) turned in a great performance in the first quarter-a 23.9% gain against considerable headwinds. I see those headwinds falling in velocity for the remainder of 2012, which suggests good things for the stock.

With the ADRs trading at $9.95 today as of 2 p.m. New York time, I'll continue to hold these shares in my Jubak's Picks portfolio. I am cutting my target price for the end of 2012, however, to $14.80 from $16.80, due to the relatively slow recovery in Brazil from the growth slump engineered in 2011 by the country's central bank in order to fight inflation.

Gerdau's first-quarter gain came despite fourth-quarter results-reported on February 15-that reflected the typical seasonal weakness in steel sales. Shipments fell by 2.9% from the previous quarter, although thanks to a price increase, revenue climbed 1.1%. For the year, sales volumes climbed 4.3% and revenue rose 16%.

The higher prices that Gerdau did realize during the quarter weren't enough to totally offset higher raw-materials costs. EBITDA (earnings before interest, taxes, depreciation, and amortization) margins fell to 11.3% in the fourth quarter, from 13.5% in the third quarter. But that margin is still better than the 10.6% that the company achieved in the fourth quarter of 2010.

Looking ahead, here's what investors can anticipate.

  • First, an end to the effort to weaken the real that contributed to a 7.4% drop in the price of Gerdau in March.

The central bank and the Brazilian government have been selling the currency and restricting cash flows from overseas in an effort to keep a rising real from pricing Brazilian manufacturers out of the Brazilian domestic market.

Understandable that the government wouldn't want Brazilian industries devastated by competition from cheap imports, but a falling real cuts the price of Brazilin assets held by overseas investors. Right now it looks like the real has stabilized near 1.80 to the dollar. (For more on this currency trend, see my recent post.)

  • Second, while 3.5% growth in 2012 wouldn't look great in comparison to the 7.5% growth Brazil achieved in 2010, it's sure better than 2011's 2.7% record. With the central bank aggressively cutting interest rates since August, the Brazilian economy does look like it's speeding up-modestly.
  • Third, Brazil gets closer and closer to its big gigs hosting the World Cup in 2014 and the Summer Olympics in 2016. Spending and work on the big infrastructure projects Brazil needs to pull off those events has lagged, but does seem finally to be speeding up. Infrastructure means steel.
  • And fourth, Gerdau looks like it has decided to find a way-spinoff, sale, partnerships-to monetize its mining assets. Credit Suisse estimates they're worth about $2.8 billion. That would be a hunk of change that would add to the price of the company's shares.

Earnings per share, which fell from R$1.26 in 2010 to R$1.13 in 2011, are forecast to climb slightly in 2012 (to R$1.15) before starting to accelerate to R$1.32 in 2013 and R$1.82 in 2014.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund's portfolio here.

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