Rise in steel demand in US, Europe a relief for Lakshmi Mittal

For sector specialists and investors, earnings before interest, tax, depreciation and amortisation (Ebitda) is the most important metric to judge the prospects of a steel-producing entity. Unsurprisingly, the outlook for shares of ArcelorMittal, which produces more steel than the combined output of the world's second- and third-largest steelmakers, has improved significantly on Chairman Lakshmi Mittal's announcement this year there Ebitda would rise to $8 billion from $6.9 billion last year. In 2013, the Ebitda rose 11 per cent over the previous year.

As is the case with peers in the West, ArcelorMittal has been on the ropes in recent years, with steel demand falling, particularly in Europe, and product prices not covering making costs. After four years of aggressive cost cutting, process optimisation, laying off unproductive capacity after overcoming opposition from unions and the governments of host countries, and progressively reducing balance sheet leverage, Mittal is "cautiously optimistic" on the outlook.

The optimism has a few caveats. This year, the group's steel shipments have to rise three per cent over last year's 84.3 million tonnes (mt) and marketable iron ore shipments 15 per cent over the 35.1 mt in 2013. More, the yearly average price of ore with iron content of 62 per cent should be $120 a tonne (cost and freight China). This is, however, doubtful. Last year, ArcelorMittal produced 91.2 mt of crude steel and 58.4 mt of iron ore. Mittal's recent optimism resulting from his finding "all indicators are moving in a positive direction" is in contrast to his statement a year earlier that challenges would continue after "a very disappointing" 2012. Fortuitously, the group's "optimisation plan" is complete, coinciding with initial signs of an improvement in steel fortunes. Mittal says his company won't cut any more capacity. In eastern Europe, however, capacity cuts might still be warranted.

The bitterly-fought Arcelor takeover in 2006 gave Mittal the capacity he longed for, as well as access to a storehouse of intelligent ways of making steel. At that point, he realised sustainability of business demanded a multi-location mining network, an independent profit centre. In the past few years, while there was a virtual freeze on steel capacity expansion, whatever money the group could lay its hands on was used for expansion of mining, particularly in West Africa and Canada. So far, the group is well on target to building capacity to produce 84 mt of iron ore by 2015 through expansion of operating mines and acquisition of new high-quality assets.

BHP Billiton, Rio Tinto and Vale are examples of miners emerging from downturns in commodities with minimum impact on margins, as they have big portfolios of quality assets and low-cost operation. They have repeatedly demonstrated capacity to cut costs to insulate themselves from any market weaknesses. In fact, they have surprised the market by improving returns in the event of flat or weak commodity prices and upholding shareholder value through the highs and lows of a business cycle.

ArcelorMittal has structured its steadily expanding mining business so as to make increasing deliveries to its network of steel mills in various geographies, as well as to the outside market. Its business model is different from SAIL and Tata Steel, which will mine iron ore for captive use.

The consensus forecast of investment analysts in the West tracking ArcelorMittal suggests the company will outperform peers in the stock market. The analysts took into account the fact that the company managed to cut debt $5.7 billion to $16.1 billion in 2013 (the company's lowest), the positive free cash flow and the steadily improving Ebitda. In case ArcelorMittal is past the cost-cutting road, its next balance sheet won't show further write-offs, another positive for the company. What will also favour the stock is its resolution to further cut debt to $15 billion. The "improvement in the overall economic situation" has led ArcelorMittal to expand capacity in Canada to enable it to have a bigger share of the automotive steel market there, and in Brazil, where it wants to capitalise on demand growth in the infrastructure sector.

Mittal's unique stature in the global industry is built on his serial success in takeovers. In a few cases, he emerged the winner even when the situation was complex and involved many other ambitious entities. Recently, he bought a 5.3-mt finishing mill in the US from ThyssenKrupp, leaving other suitors behind. The $1.55-billion acquisition, to complement the group's operation in the American continents, will allow ArcelorMittal to push greater volumes of products to the automobile and energy sectors in the southern parts of the US. Mittal has estimated four per cent expansion in the US steel market and two per cent growth in the European Union. But he foresees a slowdown in demand in China, Brazil and the former Soviet nations. Experts say this year, steel demand growth in China, at three per cent, will lag the rest of the world, the first time in six years.