Last week, I made a promise that I'd abandon my unfocused ways and dig in on five stocks that look particularly interesting right now. Taking center stage right now is ArcelorMittal (NYSE: MT), the 500-pound gorilla of global steel production.
I'll start by saying that I am not an expert when it comes to metals and materials, let alone the steel industry in particular. So why would I even consider investing in a company like ArcelorMittal?
Knowing what I don't know -- that is, the dynamics of the steel industry -- will keep me from trying to wax poetical on the topic and trying to make any sort of predictions that hinge on that part of the picture. On the other hand, there are some things that I do know, namely:
- What it means to be a vertically integrated, global leader with scale.
- The importance of savvy, committed leadership with a sizable ownership interest.
- The signposts of solid financial performance.
- What an attractively priced stock looks like.
Let's take a closer look at each of these points.
Bigger can definitely be better
There are good businesses, and there are great businesses. What separates the two? A, if not the, key is what many investors refer to as a company's "moat." Just as with the castles in King Arthur's day, a strong moat keeps competitors at bay. This allows a company with a strong moat to be able to produce above-average returns over a long period of time.
ArcelorMittal has a moat in the form of scale. Simply put, the company has a massive footprint in the steel industry, towering over competitors like Hebei Iron and Steel, POSCO (NYSE: PKX), and United States Steel (NYSE: X) when it comes to steel production. While size can mean a company is simply bloated, it can also mean the company enjoys more efficient production, has a better negotiating position with suppliers, and can offer customers a more reliable supply line. I believe the latter situation is the one in which we find ArcelorMittal.
Committed leadership
Lakshmi Mittal was the architect behind Mittal Steel, a company he founded and built for decades through mergers and acquisitions. His deal making reached a high point in 2006 when he agreed to merge Mittal with steel giant Arcelor, creating ArcelorMittal. This is no industry piker managing solely through high-level deal making and university theories -- Mittal is a committed steel man, having started his career working in his family's steel business.
Insider ownership can be a pretty big selling point for an investment. For a small public shareholder, it's a meaningful show of confidence when an executive has a serious amount of his own worth at risk in the business. How meaningful is this metric? Fool co-founder Tom Gardner has said that if he were forced to pick just one metric to choose an investment on, insider ownership would be it.
For a $31 billion business like ArcelorMittal, it's unusual to see an executive own a really substantial stake in percentage terms. Larry Ellison owns 22% of Oracle and Larry Page and Sergey Brin each have an 8% stake in Google, but in general, you don't see percentage ownership levels nearly that high in multibillion-dollar businesses. That's where ArcelorMittal is pretty unusual -- Lakshmi Mittal owns more than 41% of ArcelorMittal.
To be sure, heavy insider control like that has its risks, but generally speaking, it's a very good sign.
The numbers don't lie
The steel industry is cyclical, so it's to be expected that ArcelorMittal's performance is going to fluctuate with swings of the industry and the economy more broadly. A look at the company's recent numbers may not be particularly impressive -- for the past 12 months, it's reported a slim 3.6% net income margin and a 4.9% return on capital. However, if we look back over the decade ending in 2010 -- a decade that included two recessions -- we see an average return on capital of 14%.
Meanwhile, the company has done a very good job managing the business through cycles and maintaining profitability. There has only been one year in the past decade (2001) when the company had an operating or net loss for the full year.
ArcelorMittal has also significantly improved its balance sheet over the years. In the worrying times of 2001, the company had a debt-to-equity ratio of 704% and its EBITDA-to-interest expense ratio was just 0.2. At the most recent quarter, the company's debt-to-equity ratio was 42% and over the past 12 months EBITDA was 6.2 times its interest expenses. Importantly, that latter ratio stayed relatively comfortable even during the worst of the last recession, falling to a still-reasonable 3.8 in 2009.
That's one cheap stock
As I noted above, I'm no steel industry expert, so that puts me at a bit of a disadvantage in trying to value ArcelorMittal by predicting future earnings. Comparing its multiples to other companies and the market broadly, the stock's current multiples look attractive -- enterprise value-to-sales is 0.7, enterprise value-to-EBITDA is less than five, price-to-trailing earnings is 8.7, and price-to-forward earnings is 5.6. But in a cyclical industry, current-year multiples can often be misleading, so I'm not willing to hang my hat on those.
So what do we do? Recently, I looked at five stocks that were particularly cheap on the basis of average 10-year earnings. This was a favorite measuring stick of value godfather Ben Graham and is the concept behind the broad-market valuation that Yale economist Robert Shiller uses. The idea is that when you average earnings over a decade, you capture the effects of both up cycles and down cycles and get a more accurate picture of a company's earnings power, which you can then relate to today's price.
And wouldn't you know it? ArcelorMittal was one of the companies that made my list in the previous article. With a price-to-average 10-year earnings of just 7.3, the stock looks almost undeniably cheap to me.
My take
An investment in ArcelorMittal would require extra work on my part because I'd have to get more up-to-speed on an industry that I'm not intimately familiar with. That's sort of a strike against it (only "sort of" because I do enjoy getting my learn on). On the flip side, the points that I've outlined above are very strong selling points for an investment. And as a big fan of dividends, the case isn't hurt by the stock's nice dividend yield; though it's notable that the dividend has been slashed by half from its peak level in 2008.
As of right now, this is very much in contention for the top spot on my buy list -- currently jockeying for that spot with Home Depot (NYSE: HD), which I looked at last week. But no winner will be crowned until I've reviewed all five of the stocks that I've set out to dig into. Stay tuned for those dispatches and my pick of the eventual winner.
In the meantime, hopefully I've given you a lot to think about. As you digest this and dig into the numbers yourself, you should go ahead and add ArcelorMittal to your watchlist to keep up with what's going on at the company. Don't have a watchlist? You're in luck, you can start one for free by clicking here.
