2023-08-07 03:52:17 ET
Summary
- Companhia Siderúrgica Nacional's financial performance in Q2 2023 was impacted by falling steel prices and operational challenges, leading to a decline in the EBITDA margin.
- The company faces difficulties in promoting volume at the expense of realized prices, affecting profitability in the steel and mining sectors.
- SID's valuation is stretched, with a forward P/E ratio of 22x, significantly higher than the industry average, making it less appealing compared to peers like Gerdau and Usiminas.
Companhia Siderúrgica Nacional ( SID ) ("CSN") holds the position of Brazil's second-largest iron ore exporter and is among the top five competitors in the international market. However, the company's revenues are susceptible to economic fluctuations, changes in commodity prices, and market demand, reflecting the performance of the steel and mining sectors.
The company's revenue streams originate from three core business segments. The primary segment involves steelmaking, which manufactures diverse steel products in the construction, automotive, and infrastructure sectors.
Additionally, CSN derives substantial revenues from mining activities, including exploration, iron ore extraction, and trading. Given the importance of iron ore in steel production, the company exports this resource to global markets. Furthermore, CSN operates a cement segment that produces and markets cement and related products for construction and industrial applications.
In recent years, macro dynamics have posed challenges for the company, as steel and mining businesses are sensitive to weaker global growth, leading to lower iron ore and steel prices in recent months. As a result, CSN's financial results have been modest, with limited catalysts for improved prospects in the medium to long term. Moreover, although CSN's valuation is discounted compared to peers, there may be better investment options available in Brazil's steel and mining industry.
The weight of iron ore and steel prices on the company's performance
CSN shares experienced a mixed performance in the first half of 2023, with a promising start followed by steel demand challenges. Despite a turbulent 2022, the company's shares rebounded nearly 40%. Throughout the past year, the metal commodities market faced uncertainties driven by global recession risks, the Russia-Ukraine conflict, and slower economic growth in China. These factors resulted in significant fluctuations in iron ore prices, which surged to $160/t and later plummeted to $80/t by October.
Against this backdrop, CSN's iron ore production 2022 totaled 33.7 million tons, reflecting a 7% decline compared to the previous year. The volatile iron ore conditions impacted the company's operations, leading to decreased output compared to the preceding period.
In the first quarter of this year, the easing of China's Covid zero policy and incentives provided to the Chinese real estate segment sparked prospects of increased demand for iron ore in the medium term. As a result, international iron ore prices rallied, reaching $130/t, which, in turn, boosted CSN's share price.
However, aside from its reliance on quoted iron ore prices, CSN faces a significant need for capital expenditures. The industry's capital-intensive nature requires substantial investments in infrastructure, costly mining equipment, regulatory compliance, and resource exploration and expansion.
These high capital expenditures, particularly in the steel division, which saw a 33% YoY increase in the most recent quarter, have led to a negative FCF margin carryover of 4% in the near term, contrasting with the industry average of 3% positive. This means the company generates negative free cash flow relative to its total revenue.
Additionally, the steel division trades at a 20% premium compared to steel imported from China. However, there is a possibility that this spread may reduce due to expected interest rate cuts in China, leading to a gradual increase in downstream steel demand. Despite these efforts, CSN has faced challenges in promoting volume at the expense of realized prices, impacting its profitability.
Companhia Siderúrgica Nacional's latest results
CSN's Q2 financial results showed weakness, as the steel, mining, and cement segments faced challenges, partially offset by improved performance in energy due to new prepayment contracts aimed at reducing indebtedness, and in logistics through the issuance of simple debentures, raising R$700 million for investments in railway infrastructure.
The company reported an adjusted EBITDA of $2.26 billion, reflecting a 30% decline in EBITDA margin compared to the previous year. Notably, the mining sector experienced a significant drop, with EBITDA falling by 45%. CSN attributes this compromised performance to the direct impact of lower ore prices, negative pressure from provisional prices, and higher costs in the steel industry.
Companhia Siderurgica Nacional's IR
During 2Q23, CSN's capital expenditures (Capex) amounted to R$ 991 million, representing a 33% increase from the previous quarter. This growth was primarily driven by investments in repairing the coke batteries at UPV and making progress in mining projects.
The company's working capital was influenced by reduced accounts receivable and a sharp decrease in inventories, aligning with the increased commercial activity witnessed during the quarter.
Looking ahead, during the earnings call, CSN's CFO Marcelo Cunha Ribeiro indicated that the company expects to maintain or surpass similar figures (around 1 million) in the coming quarters to meet their guidance targets.
Companhia Siderurgica Nacional's IR
One positive aspect was the increase in CSN's leverage ratio, resulting in the net debt/EBITDA ratio rising from 0.89x to 2.78x (2.57x with prepayment and energy PPAs) between Q2 2022 and Q3 2023. This increase was mainly attributed to the distribution of R$ 2.7 billion in earnings during the period. The substantial Capex investment in the mining segment suggests that achieving leverage multiples below 2x in the medium term may be challenging and could impact the company's ability to meet the leverage guidance provided for 2022/2023.
Companhia Siderúrgica Nacional's IR
In Q2 2023, CSN faced persistent challenges in striking a balance between promoting volume and maintaining realized prices, which continued to impact its profitability. The company struggled to translate its operating income into a substantial net profit, resulting in a relatively weak financial performance.
Additionally, the exchange rate variation between the U.S. Dollar and the Brazilian Real, combined with the decline in the price of Hot Rolled Coil (HRC) in the Chinese market, has created an environment where imported steel has become more appealing to buyers in China than domestically produced steel.
The lower HRC price in China provides a cost advantage to foreign steel suppliers, enabling them to offer their products at competitive prices. Consequently, Chinese buyers increasingly opt for imported steel, challenging CSN and other local steel producers.
Considering these factors, the post-Q2 earnings outlook for CSN appears to have limited catalysts for significant improvement in the near term. The company must address the challenges in maintaining profitability and competitiveness amidst the evolving market dynamics.
Valuations are unattractive
CSN's valuation multiples seem notably stretched, particularly with a forward price-to-earnings ratio (P/E) of 22x, approximately 53% above the industry average. This significant premium in valuation raises concerns about the stock's attractiveness, especially when considering the projected 45% decline in the company's annual earnings per share ((EPS)) and the ongoing challenges related to steel and iron ore prices amidst a slowing global economy.
The expected impacts on CSN's free cash flow ((FCF)) have also influenced its EV/EBITDA multiples, which currently stand at 6.7x, 6% below the historical average. Despite this slight discount, the multiples still appear somewhat expensive, especially considering the reduced EBITDA estimate and weaker-than-expected steel division results.
Compared to industry peers like Gerdau ( GGB ), CSN's valuation looks less attractive. Gerdau benefits from competitive advantages, including diversified geographic exposure and lower dependence on Brazilian economic cycles, leading to more appealing EV/EBITDA multiples of 3.4x, 40% below historical averages of 5.6x.
Additionally, compared to Usiminas ( USNZY ), CSN's valuation multiples are relatively stretched, despite the company trading at a multiple of only 3.5% above its historical average. Usiminas, on the other hand, maintains good Capex and is expected to maintain a net debt level that is not a cause for concern.
The bottom line
Companhia Siderúrgica Nacional and the steel and mining industry are facing significant challenges due to weaker global economic growth, which has recently negatively impacted iron ore and steel prices.
In the steel segment, the Brazilian and Chinese markets are experiencing limited demand, with the reopening process falling short of expectations. This lackluster demand affects CSN's revenues and exerts pressure on costs due to the reduced ability to spread expenses across higher production volumes.
With iron ore prices hovering around an average of $110/t, the Brazilian steel sector is expected to experience further strain as future cost discounts become more likely, particularly for flat steel.
CSN's limited free cash flow generation in recent quarters and tempered EBITDA growth expectations add to the concerns. In comparison, Gerdau emerges as a more appealing option in the sector, as well as Usiminas, as it trades at more favorable and discounted multiples compared to CSN.
Given this bearish outlook for CSN, I prefer to adopt a cautious approach and stay on the sidelines. While I do not recommend establishing a short position in a single stock due to diversification considerations and risk tolerance, a long-short trade involving CSN and Gerdau could be a viable strategy. This approach aims to manage exposure to commodity-driven companies, with CSN placed on the short side.
For further details see:
Companhia Siderúrgica Nacional: EBITDA Margin Suffers Amid Steel Price Drop And Operational Challenges