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KEY CALL: Digging Deeper - Too soon to buy,
underweight steels
Metals
Rodolfo R. De Angele, CFAAC
(55-11) 3048-3888
rodolfo.r.angele@jpmorgan.com
Fabio Bevilaqua
(55-11) 3048-3403
fabio.z.bevilaqua@jpmorgan.com
Banco J.P. Morgan S.A.
Summary Ratings and Estimates
Company Price Rating Price Target PT End Date Metric Current FYE Next FYE
Companhia Siderurgica Nacional ($) 15.16 N ($) 24.10 Dec-09 Revenues (R$ mn) 14,459 (R$ mn) 14,080
prior ($) 46.40 Dec-08 (R$ mn) 16,516 (R$ mn) 23,384
Gerdau S.A. (R$) 15.88 OW (R$) 26.70 Dec-09 Revenues (R$ mn) 40,865 (R$ mn) 31,534
prior (R$) 54.00 Dec-08 (R$ mn) 45,238 (R$ mn) 55,453
Ternium ($) 9.31 OW ($) 16.50 Dec-09 Revenues ($ mn) 8,584 ($ mn) 4,156
prior ($) 50.40 Dec-08 ($ mn) 10,366 ($ mn) 11,527
Usiminas (R$) 29.24 UW (R$) 41.20 Dec-09 Revenues (R$ mn) 15,418 (R$ mn) 11,998
prior OW (R$) 95.55 Dec-08 (R$ mn) 17,703 (R$ mn) 21,897
Source: Company data, Reuters, J.P. Morgan estimates. All prices as at 22 Jan 09.
See page 48 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may
have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision. Customers of J.P. Morgan in the United States can receive independent, third-party research on the company or companies
covered in this report, at no cost to them, where such research is available. Customers can access this independent research at
www.morganmarkets.com or can call 1-800-477-0406 toll free to request a copy of this research.
Table 1: Latam Peers Multiples
EV/EBITDA P/E
Company 09E 10E 09E 10E
CSN 5.7 4.6 11.7 8.6
Gerdau 6.6 5.0 18.1 10.2
Grupo Simec 6.2 3.5 13.9 6.5
Siderar 4.8 2.3 2.0 1.4
Usiminas 7.6 7.4 15.3 10.7
Ternium 4.6 3.0 20.0 5.7
Latam Average 6.3 5.2 15.1 9.2
Source: J.P. Morgan estimates and Bloomberg.
Table 2: Most/Least Preferred Stocks
Under Our Coverage
Ranking Company Ticker Rating
1º Bradespar BRAP4 BZ OW
2º Vale RIO/P; RIO OW
3º Gerdau GGBR4 BZ;
GGB US
OW
4º Ternium TX US OW
5º CSN SID US N
6º GMexico GMEXICO
B MM
N
7º Lupatech LUPA3 N
8º Usiminas USIM5 BZ UW
9º Southern
Copper
PCU US UW
Source: J.P. Morgan.
• Still risky, underweight on Steels on expectations of a very tough ‘09. In our
view, stocks already price in a weak 4Q08 and a recovery starting in 2Q and
strengthening in 2H09. However, we believe that 1Q09 will surprise as an even
worse quarter than 4Q08 and that during the earnings season, guidance will still
provide little visibility in terms of a potential recovery, increasing the chances
of a delayed recovery in the sector, which, in our view, is not yet priced in, and
is the main reason we believe investors should underweight the steel sector
ahead of earnings season.
• Binary outcome for the sector. Our base case is still that a recovery will be
seen throughout ’09. However, a late recovery could have more serious
consequences for steel stocks. Companies can work at a fraction of their
production capacity for only so long. Liquidity pressures may force individual
companies to give up production discipline, putting supply-side pressure on a
weak demand scenario, bringing further downward pressure on steel prices and
earnings of steelmakers.
• A deeper look at the key themes for '09. In this report, we also examine some
key themes that should affect steel companies throughout the year. We highlight
our proprietary analysis of the flattening effect of the steel cost curve and our
pricing forecast model for steel. Liquidity remains a key issue, and we expect to
see consolidation in the industry as the trade-off between buying or building will
be constantly revisited. Finally, we are more cautious towards Brazilian demand
for durable goods and for this reason, we prefer exposure to long (Gerdau) rather
than flat steels (CSN and Usiminas) in Brazil.
• Downgrading Usiminas to UW. We are adjusting our Dec09 target prices for
all steel producers and bringing earnings estimates down by 49-75%, about 24-
44% lower vs. consensus, which should trend down. Our Usiminas downgrade
to UW from OW is explained mainly by its high exposure to the auto and auto
parts industries in Brazil. It trades at 7.6x ’09e EV/EBITDA, a 21% premium to
peers. We maintain our N rating on CSN as despite our preference for long steel,
it should benefit from ramping up its iron ore business. CSN trades at 5.7x ’09e
EV/EBITDA. We maintain our OW ratings on Ternium and Gerdau. The first,
mainly based on valuations (‘09e EV/EBITDA of 4.6x is ~28% discount to
peers), while in the case of Gerdau, we believe its mini-mill profile should
benefit the company during the shutdown periods, with Brazilian operations
driving performance in ’09 and NA operations in ’10, benefiting from US fiscal
stimulus and compensating a slowdown in Brazilian operations.
Table of Contents
Still too early for a top down call – stay underweight on
steels .........................................................................................4
‘09: Reality Check After the ’08 Party .....................................9
1. Steel prices should go down.............................................10
2. Domestic prices should go down; weaker currencies
should act as buffers .............................................................14
3. Working Capital pressures – can the industry fill the gaps
left by the banks?...................................................................17
4. Growth: Capex vs. M&A.....................................................19
5. Risks to domestic (Brazilian) demand remain high.........22
Lowering estimates and price targets ..................................25
CSN – cautious on domestic demand risks .........................27
Ternium – the cheapest of all ................................................30
Risks to Our Rating and Price Target ...................................32
Gerdau: well positioned to face the crisis............................33
Usiminas: Downgrading to Underweight – mounting
domestic risks ........................................................................36
Appendix 1: Economic assumptions under our base case
scenario...................................................................................39
Appendix 2: CSN Financial Models and DCF Calculations.40
Appendix 3: Ternium Financial Models and DCF
Calculations ............................................................................42
Appendix 4: Gerdau Financial Models and DCF Calculations
.................................................................................................44
Appendix 5: Usiminas Financial Models and DCF
Calculations ............................................................................46
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