2023-08-05 14:55:19 ET
Summary
- Companhia Siderúrgica Nacional is given a Hold rating amid headwinds from a slowdown in overseas steel markets and China's struggling economy.
- The steel division faces challenges from lower sales to foreign customers and increasing competition from imported products.
- The mining division benefits from Chinese demand but iron ore prices are weak.
- Business divisions within the SID group may come under more pressure if the economies of the most industrialized countries enter a recession. But the financial position seems solid enough for a worry-free ride to the next recovery.
A Hold Rating for Companhia Siderúrgica Nacional
This analysis suggests a Hold rating for shares of Brazilian vertically integrated steelmaker Companhia Siderúrgica Nacional (SID).
Before regular market hours on August 3, Companhia Siderurgica released the financial results for the second quarter of 2023, reflecting a decline in overseas markets for its steel division and weaker price conditions for its iron ore division as China's economic recovery struggles to gain momentum.
These headwinds are expected to persist for some time, actually heralding the onset of an economic recession that could put downward pressure on the stock price.
About Companhia Siderúrgica Nacional
Headquartered in São Paulo, Brazil, Companhia Siderúrgica Nacional is an integrated steel producer with operations in Brazil and other Latin American countries. The company operates in five segments:
- The steel division is the largest contributor to the company's consolidated revenue but the second-largest contributor to Adjusted EBITDA. In the second quarter of 2023, it contributed 54% and 24.4% of revenue and EBITDA, respectively. The segment includes the manufacture and supply of several steel products useful to companies in the distribution, packaging, automotive, appliance, and construction industries.
- The mining division is the second-largest contributor to the company's consolidated revenue but the first contributor to Adjusted EBITDA. In the second quarter of 2023, it contributed 33% and 49.20% to revenue and EBITDA, respectively. The mining division includes exploration for iron ore reserves at the Casa de Pedra and Engenho mines in the city of Congonhas, state of Minas Gerais. The business segment also includes limestone and dolomite mining activities at the Bocaina mine in the city of Arcos, Minas Gerais state, Brazil, and produces tin.
- The logistics division is the fourth largest contributor to the company's consolidated revenues and the third largest contributor to adjusted EBITDA. In Q2 2023, it contributed 6.6% and 16.10% to revenue and EBITDA, respectively. This division operates railway and port facilities.
- The energy division is the smallest contributor to the company's consolidated revenues and adjusted EBITDA. In Q2 2023, it contributed 1.3% and 3.10% to revenue and EBITDA, respectively. The energy sector includes power generation from thermoelectric combined heat and power and hydroelectric power plants.
- The cement division is the third contributor to the company's consolidated sales but the fourth contributor to adjusted EBITDA. In the second quarter of 2023, it contributed 10.4% and 9.9% to revenue and EBITDA, respectively. This division produces and sells cement to building material merchants, home centers, concrete manufacturers, construction companies, mortar industries, and manufacturers of cement artifacts.
To get a better idea of how Companhia Siderúrgica Nacional's consolidated sales and adjusted EBITDA were distributed across its 5 business segments, the following two pie charts may help.
This pie chart illustrates each of SID's five business segments as a percentage of the company's consolidated revenue for Q2 2023 (before deletions):
Source of data: CSN 2Q22 and 2Q23 FINANCIAL RESULTS
This pie chart illustrates each of SID's five business segments as a percentage of the company's consolidated adjusted EBITDA for Q2 2023 (before eliminations):
Source of data: CSN 2Q22 and 2Q23 FINANCIAL RESULTS
Furthermore, the following two charts next to each other show that:
- a lower contribution of the Steel Division to consolidated net sales (-1,883 basis points year-on-year) resulted in a larger decrease (-3,400 basis points year-on-year) in this division's contribution to consolidated Adjusted EBITDA.
Source of data: CSN 2Q22 and 2Q23 FINANCIAL RESULTS
- A higher Cement division contribution to consolidated net sales (+590 basis points year-on-year) resulted in a smaller increase in this division's contribution to consolidated Adjusted EBITDA (490 basis points higher year-on-year).
- While Mining (Year-over-year, 832 basis points were added to consolidated net sales vs. 2,070 basis points added to consolidated adjusted EBITDA), Logistics (26 basis points vs. 620 basis points), and Energy (86 basis points vs. 330 basis points) all made a larger contribution to consolidated Adjusted EBITDA than consolidated net revenue, while both income lines grew year over year.
A Look at the Company’s Divisions
The steel division suffered from lower sales of steel production delivered to foreign customers (down 9.3% to 311,000 tonnes in the second quarter of 2023), while sales of steel products in the domestic market developed better as a result of the important recovery of flat steel delivered to construction, home appliances, and distribution Brazilian industries (the domestic market was up 2.1% year-on-year to 739,000 tonnes in Q2 2023).
Overall, the steel division sold 1,051 tons of steel products in the second quarter of 2023, down 1.5% year-on-year, mainly due to lower orders from overseas customers, especially from European customers. Higher borrowing costs to counteract increased inflation are having a negative impact on households, companies, and growth projects.
The headwinds for the steel division do not end there, in the sense that the increasing penetration of imported products is pushing the prices of the company's steel products in both domestic and foreign markets.
The steel division is showing some ability to keep prices resilient in domestic markets and offset some of the headwinds. However, this has not prevented revenues from deteriorating so far. In fact, the steel division reported revenue of 5.943 billion Brazilian reals [BRL] (or $1.23 billion) in the second quarter of 2023, down 23% year over year in local currency terms.
It is very likely that this negative trend in the steel divisions' sales may continue for a few more quarters. Price pressures from an increased presence of foreign products could intensify due to the continued strong expansion of the Indian economy and the possible release of stimulus measures promised by the central government of the People's Republic of China to boost the country's economy.
Slower momentum in the overseas market, which is responsible for muted demand and lower price conditions, should not abate as Western countries' economies head into recession, which is expected to occur between the last quarter of 2023 and early 2024. For the US economy, the world's leading economy and the benchmark for most developed countries, US housing player giant Fannie Mae and credit rating agency Fitch recently hinted at a sharp downturn in the business cycle. The credit rating agency has lowered the US's long-term credit rating from AAA to AA+.
But also in the domestic market, headwinds may soon emerge, translating into lower sales volumes, as Brazilian customers are experiencing lower purchasing activity on their part, which they seem to be resolving by placing fewer orders and staff downsizing.
Indeed, domestic customers have participated in nine straight months of a decline in Brazilian factory activity in response to weaker consumer demand, as the tightening monetary policy by Brazil's central bank has yet to prove effective in countering unfavorable inflationary dynamics .
The cost of steel production which was BRL 4,113 per tonne of steel (or USD 853.32/ton) in the second quarter of 2023 – down 6.2% year-on-year – is likely to continue to benefit in the coming quarters from lower and lower inflationary pressure on production inputs, although the risk of the resurgence of the inflationary issue still exists due to the presence of geopolitical tensions in the world.
Costs also benefit from the normalization of the company's own production of flat-rolled products and plates, resulting in a spread of fixed costs over greater production and less dependence on purchasing plates from third parties.
The continuous improvement in the cost structure will have a positive effect on the Steel Division's profitability. However, the size of the lag between the EBITDA margin of 24.7% in Q2 2022 and the EBITDA margin of 9.3% in Q2 2023, amid downside risks still weighing on growth, makes the recovery of the steel division quite uncertain today.
The mining division of Companhia Siderúrgica Nacional was impacted by a 19.6% year-over-year decrease in iron ore prices to $110.9/DMT (Platts, Fe62%, North China) in the second quarter of 2023, as iron ore demand for steelmaking felt the pain of weakening Chinese momentum. The price of iron ore was $137.9/DMT (Platts, Fe62%, N. China) for the second quarter of 2022.
China Visualizing the World's Largest Iron Ore Producers the largest consumer in the world of iron ore and China Top countries iron ore imports global share 2021 | Statista also the largest importer in the world of iron ore, accounting for an impressive 70% of the world's total iron ore imports.
China uses iron ore to power its domestic steel production, which has managed to remain at a strong level thanks to the support of other strategic sectors such as the infrastructure and automotive sectors. This situation allowed Companhia Siderúrgica Nacional to get back on track with iron ore production and sales volumes to be reached by the end of the year 2023 (from 39 to 41 million tons).
Thus, the company benefits from still strong Chinese demand for iron ore so that its operations reached record production and sales volumes of 11.16 million tons and 11.26 million tons, respectively, in the second quarter of 2023. Production increased by 34.7% while sales volumes increased by 48.6% both year-on-year.
However, the lower price weighed on adjusted net revenue, which fell 39.2% YoY to BRL 3.63 billion (or $753.3 million) in Q2 2023, impacted the unitary net revenue, which fell 8.3% YoY to $66.06 per wet ton, and kept the entire mining division from getting the credit it deserves in terms of profitability.
In fact, the adjusted EBITDA margin was 30.6% in Q2 2023 compared to the adjusted EBITDA margin of 35.7% in Q2 2022.
The price at which iron ore is sold is critical to the mining division of Companhia Siderúrgica Nacional and the estimates of future prices by Trading Economics analysts are not reassuring. Although using a different benchmark, they predict a downward trend (click on the “forecast” section of this webpage ).
While iron ore prices recently showed signs of recovery amid rumors that the central government could take steps to strengthen the real estate sector, which is vital to China's economy, these are unlikely to consist of large-scale stimulus. This is because there are no premises for the Chinese economy to gain the desired momentum in a global macroeconomic framework in which two of the three fundamental trading partners (US and Europe) -- ASEAN is the third one -- are grappling with the onset of a probable economic recession. Against this background, the large-scale stimulus measures are unlikely to boost China's economic growth and thus will not create a favorable environment for rising iron ore prices.
The logistics division is performing as follows (growth rates are in local currency):
- Rail Logistics net revenues increased 12.8% year-over-year to BRL 668 million (or $138.6 million), leading to a 21.5% year-over-year increase in the Adjusted EBITDA to BRL 362 million (or $75.1 million) in the second quarter of 2023. The adjusted EBITDA margin was 54.2% in the second quarter of 2023 compared to an adjusted EBITDA margin of 50.3% in the second quarter of 2022, an increase of 390 basis points. The subdivision benefits from the normalization of the activities of certain affiliated companies engaged in the rail logistics of the Companhia Siderúrgica Nacional.
- Port Logistics at Sepetiba Tecon in Itaguai Municipality, Rio de Janeiro State , recorded the following trends in flows comparing Q2 2023 to Q2 2022:a decrease of 28.2% for 221,000 tons of steel products shipped, an unchanged growth rate in relation to the 15,000 containers shipped, a decrease of 50% for 2,000 tons of general cargo shipped, and a decrease of 74.4% for 56,000 tons of bulk cargo shipped in the second quarter 2023.
In local currency, the division reported net revenues of BRL 54 million (or $11.2 million) in Q2-2023, down nearly 30% year-over-year, resulting in an 87.5% drop in adjusted EBITDA to 3 million BRL (or $0.6 million).
Port Logistics achieved an EBITDA margin of 5% in the second quarter of 2023, compared to an EBITDA margin of 31.3% in the second quarter of 2022.
The probable recession, which is expected to take place between 2023 and 2024, certainly gives no reason to expect a significant improvement in the performance of the logistics division of Companhia Siderúrgica Nacional in the foreseeable future.
Overall, logistics saw a 15.4% year-over-year increase in net revenue to BRL 772 million (or $160.2 million) combined with a 13.4% year-over-year increase in adjusted EBITDA to BRL 365 million (or $75.7 million). So, the adjusted EBITDA margin was 47.3% in the second quarter of 2023 compared to the adjusted EBITDA margin of 48.1% in the second quarter of 2022.
The energy division generated a net income of BRL 159 million (or $33 million), which grew 3.4 times year over year, while the adjusted EBITDA of BRL 69 million (or $14.3 million) in the second quarter of 2023 was a positive change from a negative adjusted EBITDA of BRL 6 million in the second quarter of 2022. The adjusted EBITDA margin of 43.4% was in Q2 2023 versus a negative margin in Q2 2022.
Climate factors affecting hydropower water levels cause fluctuations in energy prices. These factors cannot truly be predicted but are to be expected based on recent trends driven by climate change.
If an economic downturn occurs in Brazil as a result of the central bank's anti-inflation measures, and in the wake of a US recession as suggested by Fitch and Fannie Mae, the negative business cycle will certainly affect the amount of energy needed for industrial use and other activities with downward pressure on energy prices.
The cement division sold 3.333 million tons in the second quarter of 2023, an increase of 11.7% compared to the previous year's quarter. However, the second quarter of 2022 accounts for the proforma volume driven by the acquisitions of the Lafarge Holcim plants, with which Companhia Siderúrgica Nacional aims to have more than 270 integrated cement plants worldwide and grinding stations in up to 50 different countries.
Net sales reached BRL 1.142 billion (or $236.9 million) in the second quarter of 2023, growing 2.4 times year-over-year in local currency, as a result of higher production with the last factor causing a lower unit cost as fixed costs could be spread over a larger production volume.
The segment's adjusted EBITDA was BRL 224 million (or $46.5 million) in the second quarter of 2023, up 37.4% year-over-year, but the adjusted EBITDA margin of 19.6% in the second quarter of 2023 was lower compared to the adjusted EBITDA margin of 34.2% in Q2 2022 .
The exploitation of synergies from the integration of the Lafarge-Holcim plants and the lower raw material costs contribute to improving the profitability of the cement business. Regarding the price of cement, it was mainly influenced by the following situation, as shown in the financial report for the second quarter of 2023 of Companhia Siderúrgica Nacional. Given the high levels of household debt, Brazilians had little faith in monetary policy to fight inflation. This translated into weak demand which weighed on cement consumption through a slowdown in activity in the construction and infrastructure sectors. The government introduced some federal programs in an attempt to revive the sectors.
However, the expected improvement in the pricing scenario should help margins overcome the pressure they have been under for the past year or so, and improved consumer confidence should ensure that.
In fact, as signaled by the rise in the FGV-IBRE Consumer Confidence Index, there is an improvement in both the current sentiment of Brazilian consumers and their perception of the future.
“The result was mainly due to a further decline in price inflation, better salaries, and promising expectations regarding programs that aid consumer debt”, reports Trading Economics.
The Financial Condition
Adjusted cash flow in the second quarter of 2023 was BRL 745 million (or $154.6 million), down slightly from BRL 830 million (or $158.4 million) in Q2 2022.
A total of BRL 991 million (or $205.6 million) – 18.3% higher than the previous year – was invested in the second quarter of 2023 for repair and general maintenance in the steel division, as well as expansion projects in the mining division and maintenance in the cement and energy divisions.
Nevertheless, the balance sheet remains solid.
As of June 30, 2023, the balance sheet had BRL 12.47 billion (or $2.59 billion) in cash on hand and short-term investments, while the consolidated net debt amounted to BRL 31.46 billion (or $6.53 billion) with the leverage indicator of the LTM ratio net debt/EBITDA being 2.78x.
Considering the prepayment trades for iron ore and energy and other initiatives under evaluation to reduce its indebtedness, the company says it is on track to achieve a leverage of 1.75x to 1.95x by the end of 2023.
In terms of the consolidated debt service plan, four years is the period that current pro forma cash can service capital markets and bank debt, long enough to weather the next recession and its aftermath.
As of June 30, 2023, Companhia Siderúrgica Nacional had consolidated debts of approximately BRL 41.51 billion (or S$8.61 billion), with the last obligation maturing in 2037, while total liquidity was BRL 14.87 billion (or $3.1 billion) including the prepayment operations for iron ore and energy.
The company pays semi-annual dividends. On May 24, 2023, the company paid a semi-annual dividend of $0.118 per common share and a special dividend of $0.127 per common share.
The dividend leads to a forward dividend yield of 8.47% at the time of writing. The stock in Companhia Siderúrgica Nacional consists of about 1.33 billion shares outstanding. Over the past 3 months and 10 days, 3.49 million and 2.95 million shares of SID were traded on average each day.
The Stock Valuation
As of this writing, Companhia Siderúrgica Nacional shares are trading at $2.66 per unit, giving it a market cap of $3.60 billion.
Shares are trading below the 200-day, 100-day, and 50-day simple moving averages of $2.88, $2.76, and $2.69, respectively.
The 52-week range lies between $2.20 and $3.70, so shares are currently 9.8% below the interval midpoint of $2.95.
Companhia Siderúrgica Nacional is the second largest steel producer in Brazil, as Gerdau S.A. ( GGB ) is the first. SID is ranked 93rd among the world's leading steel producers according to the ranking of the best steel producers 2022/2021.
Then it should also be considered that the company is vertically integrated as it is also active in iron ore mining and will benefit from further synergies through the integration of relevant assets in the cement division. So, there is value in a holding in Companhia Siderúrgica Nacional and this significantly reduces the investment risk.
From the perspective of this analysis, shares will be trading significantly lower than they are now, reflecting headwinds likely to arise from the recession expected between late 2023 and early 2024.
If you scroll down to the “Risk” section of this webpage , you will notice a 24-month beta coefficient of 1.52x, which means that shares of Companhia Siderúrgica Nacional are reacting disproportionately to a change in the market value of US-listed equities.
Trading Economics analysts believe the United States Stock Market Index (US30) - the benchmark for US-listed stocks - is likely to contract over the next few months as it drops from the current 35,260 points to 31,845 points within 12 months.
With a 24-month beta of 1.52x, shares of Companhia Siderúrgica Nacional could come close to $2.20 per share or the 52-week low, or fall about 14-15% from the current $2.66, creating a possibility to buy a true dip.
This type of expectation means that the 14-day Relative Strength Index should approach oversold levels.
Based on the performance of the past 52 weeks, the current RSI of 44.62x should allow the share price to fall by 10% from current levels during the expected bear market for the US stocks. Therefore, this analysis suggests not going beyond a Hold rating on Companhia Siderúrgica Nacional shares at this time.
Conclusion
Companhia Siderúrgica Nacional's steelmaking and mining divisions could fare even better, but a slowdown in overseas markets and the struggling Chinese economy prevent that at the moment. The cycle is negative, but the business divisions are showing resilience.
Business divisions within the SID group could come under more pressure if the economies of the most industrialized countries enter a recession, which is expected to occur between late 2023 and early 2024.
But the financial position seems solid enough for a worry-free ride to the next recovery.
Meanwhile, the next cycle could result in more comfortable entry points to increase exposure to this major and second-largest steel producer in Brazil.
The latest dividend from the company provides a very high yield based on the current share price, but the size of the dividend is variable as it depends on the volatility of conditions in the steel and iron ore markets above all.
Therefore, given many aspects highlighted in this analysis, it is better to wait for the clouds to clear and not move from a Hold rating for now.
For further details see:
Companhia Siderúrgica Nacional Will Face Headwinds, But Opportunities May Emerge