Brazilian steel maker Gerdau (ADR: GGB) is on the march in the U.S. steel market and back home in Brazil.
In the United States: in August, the company acquired the remainder of the shares of its 66% owned U.S. subsidiary Gerdau Ameristeel. That gives Gerdau a wholly owned platform for expanding in the U.S. market. (The acquisition of the remainder of Gerdau Ameristeel will also reduce that company’ cost of capital since parent Gerdau pays only half as much as the subsidiary in the capital markets.) The company didn’t let much moss grow on that deal. On September 15 Gerdau announced that it would acquire TAMCO, a California mini-mill that is a producer of long-steel products, such as rebar, used in construction.
In Brazil: the company is pursuing an expansion of capacity that will add a new mill producing flat rolled steel, beginning production in 2012, and diversifying the company away from long steel products. In the long steel market Gerdau is the second largest producer in the world.
Long steel has been a depressed market because of the slowdown in construction in the United States and in other economies.
I actually like that. It means that Gerdau has good upside leverage with the recovery of that market segment. And the tough times in that segment have left the company with very little competition in some markets. For example, TAMCO is the only producer of long steel products in California.
The long steel market in Brazil should also get a big boost from the government’s efforts to increase investment in infrastructure and construction as Brazil prepares to host the 2014 World Cup and the 2016 summer Olympics. Gerdau has about 20% of Brazil’s steel market.
The expansion into the flat-rolled market in Brazil will increase Gerdau’s margins (since margins in flat-rolled steel are higher than in long steel) and will also position Gerdau to sell into such fast-growing industries in Brazil as automobiles and consumer white goods.
At its current price just above $14 Gerdau trades for about 12 times projected 2010 earnings and 11 times projected 2011 earning per share. Morningstar projects revenue will climb 16% in 2010 and that operating margins, currently at 13.4%, will climb back to historical levels of 15% to 20% through 2014. The company has never had a losing year in its history, by the way.
I think the stock is likely to experience weakness in the near term due to what I’ve called the Petrobras effect (See my post https://jubakpicks.com/2010/09/21/selling-81-billion-in-petrobras-stock-may-create-bargains-elsewhere-in-brazil/ ) and to rising prices for scrap steel, an essential raw material for mini-mill producers such as Gerdau. The company is close to self-sufficient for its Latin American operations but needs to buy scrap for about 60% of its U.S. mills.
I’d use the weakness as a buying opportunity. I’m adding this ADR to Jubak’s Picks with a target price is $20 by June 2011.
Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio
Jim, GGB is in freefall. What’s the call?
GGB dropped 50 cents below my target price to buy. I’m going to give this recommendation from Jim a try. Brazil seems like a good country to invest in. Hope I’m not too early.
Thanks Yclept – I would not have found this piece of information:
“they’re carrying $8.4B worth of “Goodwill” on the balance sheet. Steel is steel! So long as it meets the appropriate ASTM and ASME specifications, there ain’t no “goodwill” about it! ”
Though Jim’s logic is correct, but I am surprised that he did not look at some of these factors. If someone wants exposure to iron/steel, this definitely better than MT.
I already own some GGB – but would hold off for a better “day” to add to the position.
Jim, interesting post. Steel seems to be out of favor with Wall St right now. Would like to know if you think this might be a good entry point for Nucor. Either 12-18 months or longer term. Keep up the great work!
they are going to need a lot of Goodwill in brazil from here until 2016 at least thats whay I hope
Gerdau down today while BOVESPA is up sharply — seems strange. I guess the market doesn’t like the $1.25B in 10 year bonds they launched today. As I read it, that will take their total debt from about $14.5B to $15.75B. The reported total D/E is .76, so these bonds will take it up to somewhere around .86, which seems pretty high to me for a steel mill. The ROA is only reported as 5.7% and they’re paying 5.875% on these new bonds — a losing proposition until the demand for steel picks up.
Finally, they’re carrying $8.4B worth of “Goodwill” on the balance sheet. Steel is steel! So long as it meets the appropriate ASTM and ASME specifications, there ain’t no “goodwill” about it! There’s price and shipping costs. I am very suspicious of “goodwill” as it applies to a manufacturer of a basic commodity. If one discounts much or all of the goodwill, then the D/E begins to look even more dangerous.
If the stock price was bumping along at a 5 year low, I’d figure it was fairly valued and waiting for the demand for steel to pick up. But it’s not. It’s trading at 3X the 5-yr low, so much of the hoped-for improvement in sales and profit seems to me to be already in the price.
I just bough GGB and SID
a 30%+ upside in 9 months… hmmm gonna have to keep my eyes on this one….. the march 2011 calls may be an interesting buy….
Jim – Thanks. As always, your info and analysis not only provide us a possible financial upside, but I learn something about different industries that previously I’ve been clueless about – and it’s actually pretty interesting info because it’s real and happening in the world around us. Great stuff!