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In the global games of international business, it's not the nimble who survive. Instead, massive size creates economies of scale, which can lead to enormous success.
Steel giant MittalSteel (NYSE: MT ) is building out such a business model. Mittal emerged from the 2004 merger of Ispat International and International Steel Group. At the time, it was the world's second-largest steel company, trailing only Arcelor in size. Fast-forward to this January, when Mittal made the equivalent of a $40 billion offer to buy Arcelor. If completed, the merger would create a company of unprecedented size, with the opportunity for vast economies of scale. But even in its current state, Mittal is a top-quality holding.
In the steel industry, controlling costs is critical. In 2004, iron ore, a primary material used in steelmaking, cost $23 to $38 a ton (depending on the type of ore, including shipping). That price soared to $38 to $58 a ton in 2005, and it's expected to increase again in 2006. But Mittal actually benefited from the iron ore price increase, because the company is the world's fifth-largest iron ore producer, and some of its mines are close to its mills. With fuel and freight costs trimming profits at many steel makers, vertically integrated Mittal has a built-in competitive advantage at some locations.
The company also boasts a strong footprint in the low-cost production regions of the world. Almost half of its 2005 shipments came from developing countries like South Africa, Ukraine, and Kazakhstan.
In addition, Mittal is the No. 1 steel producer in North America and the No. 1 producer to the automotive industry (a very significant customer base). To its merit, General Motors (NYSE: GM ) and Ford (NYSE: F ) both rank the company best in technical capability.
Do the company's results match all the hype? I'd say so. For 2005, return on invested capital was 23.9%, free cash flow was $3 billion, and Mittal's dividend increased 25%.
Anyone who follows the steel industry knows that it's a commodity market, subject to wide price swings. 2004 was a boom year, and Mittal had record profits. Last year, the spot market was weak and profits suffered -- although the metrics above prove that the company can excel even in tough times. Excluding Arcelor, Mittal expects 2006 to have stronger end-product pricing, continued strong long-term contract pricing, and further growth in steel shipments.
If the company is successful in acquiring Arcelor, there will be more to like. Besides an estimated $1 billion in synergies from purchasing, marketing, and manufacturing efficiencies, Mittal could become the world's steel supplier for globally diversified manufacturing enterprises.
Last but not least, this stock is relatively cheap compared to its peers, despite recently strong activity in steel stocks. The shares trade for 5.2 times trailing earnings. Consider United States Steel (NYSE: X ) , which trades for eight times earnings, or Nucor (NYSE: NUE ) , currently trading for 10 times earnings.
Wall Street is worried that steel earnings will evaporate in the next worldwide economic downturn-- and they may. The market's also worried that China's emergence as a net exporter of steel may upset existing supply and demand curves. Should any of the above occur, I'm most concerned about aligning myself with the low-cost leaders, trying to decide which ones will be most able to survive and dominate if and when economic conditions improve once more.
However, I don't see an economic downturn on the horizon. On some level, China and India's growth will likely continue to power the world's appetite for steel, and geographically diversified Mittal is positioning itself to be a growing but low-cost steel provider. So it's reasonable to say that in the Olympics of international investments, Mittal is a definite front-runner trading at value prices.
Check in with the other competitors:
- Best International Stock: NetEase
- Best International Stock: Lloyds TSB
- Best International Stock: Embraer
- Best International Stock: Diageo
Mittalis a Motley Fool Inside Value pick. Like things cheap? Like good things cheap? Let Philip Durell lead you to good, cheap stocks with a 30-day free trial toMotley Fool Inside Value.