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Mittal: A "Steel" from Markman
02/10/2006 12:00 am EST
With operations from Canada to Germany to South Africa, based in the Netherlands, and controlled by an Indian family, Jon Markman calls Mittal Steel "one of the most truly global companies in the world." Here, the editor of Strategic Advantage looks at this global steel firm.
"Over the past 18 months, public steel-maker stocks have taken investors on a wild run, doubling and better from the fall of 2004 through the spring of 2005, then tumbling 50% into the summer of 2005, and finally moving up a bunch again in the past six months. The old cliché about a roller-coaster ride doesn't do these moves justice. It's more like a bungee jump with some of the steel stocks exceeding their spring 2005 highs, with others seriously lagging.
"Despite the volatility, there are still many interesting and potentially profitable names in this group. But the one I find the most intriguing is Mittal Steel (MT NYSE). The company began its current incarnation in 2004 following the merger of a private Indian company called LNM Holdings with publicly held Ispat International and International Steel Group. Right now, Mittal is about 28% off its all-time high, set in March last year, and appears attractive fundamentally, technically, and on valuation.
"Considering that it is one of the three largest steel makers in the world, is well-integrated vertically, has a very low cost structure, and should achieve economies of scale going forward, it should probably trade at a premium earnings multiple. And yet it actually trades at a discount— a paltry 5 times forward multiple, vs. the 7 times the industry average. The fundamental issue that distinguishes Mittal is that it is the leading acquirer in an industry that is consolidating, and its executives have managed to avoid buying assets too richly— a common trap.
"One of the company's key advantages is its significant ‘captive’ raw material resources, which means it internally sources half of its own iron ore needs, half its coal, and 80% of its coke. It is currently increasing its integration with a large iron-ore development project in Liberia and mine expansions in Kazakhstan, Bosnia, and Mexico. About 60% of its revenue is generated in emerging markets. As it obtains inefficient assets in places like Poland and the Czech Republic, it applies its expertise and sensible, but not overly indulgent, capital expenditure budget to implement repairs, and efficiencies that are driving up utilization rates.
"Its combination of low costs, diversified manufacturing base, modest long-term debt, and light cap-ex has led to impressive cash flow— giving it the ability to raise its dividend, buy back shares and invest more. The primary danger with Mittal is that it has relatively low liquidity. Additionally, Mittal family members occupy the most senior management positions. It's nice work if you can get it. And, of course, there are the usual problems with a commodity producer, which is subject to the vagaries of steel prices (which are currently in recovery mode) and the questionable strength of the global economy.
"But considering that China continues to put up 9%+ growth, including a 25%+ jump in auto production, the world appetite for steel may be its least worrisome problem. As the global industry has consolidated, producers have closed plants and kept prices from slipping. I think Mittal deserves a higher multiple than Brazilian, Korean, American and European steel makers. Despite its size, Mittal still has a lot of opportunities ahead, including forays into Latin America, India and deeper into China via joint ventures.
"In recent news, Mittal made a bid for Arcelor, a major European-based rival. I was hoping that the offer would depress the shares of Mittal but it has been moving higher of late out of a multi-month trough. The most important part of the Arcelor deal might be the change in corporate governance that would unfold. The Mittal family would go to about 55% ownership from 90%. The float of the stock would also go way up, allowing many more financial institutions to own it. Plus the Arcelor deal would be immediately accretive to earnings, as there is not a lot of overlap between the two companies' businesses.
"The stock is still really cheap, and has a long way to go. Mittal could earn $4.41 in 2007. Apply a market-average 11 times multiple against that, and you get a target of $48.50. And if the bid for Arcelor is successful, you can bet Mittal would step in and cut a lot of bureaucratic fat. The key change for investors might be what the Street calls a 're-rating' of the shares. That means it has the potential to go from a discounted valuation to a premium valuation, or from a p/e of around 6 to around 11. If you put a reasonably optimistic spin on the situation, I think you can see the potential for the stock to advance to the $65 level in the next 36 months due to a combination of earnings growth and multiple expansion."
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