Steely times

Arcelor does more than needed, less than enough

Investors in commodities and steel are getting used to putting in more and getting back less. ArcelorMittal has taken $4.8 billion of asset impairments, recorded a $7.9-billion full-year loss, and is asking shareholders to help fund a $3-billion capital increase. That is more than what's immediately necessary, but far from enough.

The plan announced on February 5 buys the company time in the hope that steel prices recover. Over five years, EBITDA per tonne of produced steel will hopefully rise by 50 per cent, leading to an annual free cashflow of $2 billion. That, though, presupposes that there is still enough fat to cut. Costs are already down by $4 billion, and capital expenditure by $2 billion since 2012.

Arcelor's predicament is really one of pricing power, not cost control. It has long pursued vertical integration - owning the production of ingredients like coal and iron ore. That made sense when prices of those materials were high. Now, not so much. Iron ore spot prices have fallen more than three-quarters in the past five years.

The lack of pricing power bites at both ends. Iron supply has been kept at high levels by the aggressive habits of mining giants Rio Tinto and BHP Billiton. While Arcelor's iron ore production is falling slightly, the super low-cost Australians are still pouring more ore into an oversupplied market to wear away rivals.

At the other end, there are Chinese steelmakers, who have kept producing long after it stopped making economic sense to do so. According to Credit Suisse, around 90 per cent of Chinese steelmakers are producing negative cashflows. But as the sector employs four million people, China's government has a large incentive to turn a blind eye. Many apparently dormant mills are liable to restart if prices recover.

What can Arcelor do? Exactly what it is doing - cut costs, raise capital and hope for the best. After raising new equity and selling a stake in Spain's Gestamp Automoción, it should emerge with net debt of around 2.7 times forecast EBITDA for the current year. That's enough to keep it in good shape should things stabilise -whether they will is beyond Arcelor's control.