Companhia Siderúrgica Nacional Q1: weak result and risks materializing (NYSE: SID)

Investment thesis

I recommend selling Companhia Siderúrgica Nacional (NYSE:SID) actions after 1T24 results published on May 8. The company has reported mediocre results and I don’t see any triggers for near-term improvement.

As I said in my inception of coverage report, the company faces aggressive competition from Chinese steel in the domestic market. Another risk is the high leverage of 3.1x, much higher than its peers whose leverage is between 0x and 1x.

Review of Companhia Siderúrgica Nacional 1Q24 results

Companhia Siderúrgica Nacional’s results did not meet already depressed market expectations. Revenue fell short of consensus by 5.3% and the company posted a loss in the period.

Now we will talk in detail about the company’s results. In my reports, I generally cover revenues, operating results, debts, investments and profits in sequential order. However, Companhia Siderúrgica Nacional is a holding company and has relevant businesses such as mining, steel and cement, so I will comment on the results in each of the companies.

Steel – This is no longer the main activity of the holding company

It’s amazing how much the company’s divisional segment is suffering as the mining segment outperforms the steel segment and becomes the largest contributor to EBITDA.

Before we talk about the numbers, it’s worth mentioning that there has been a big evolution since I reported on coverage beginning. As I mentioned, there was a big supply problem in the market due to the large amount of steel exported from China to Brazil.

And in fact, the The government increased taxes at 25% on Chinese steel, however, the taxation will only be applied to 11 products out of a total of more than 200. In addition, the customs duty will only be 25% when a certain export quota will be achieved.

The established limit was 30% higher than the average product imports between 2020 and 2022. In other words, the measures do not meet the expectations of Brazilian producers.

Interestingly, the most exported Chinese products to Brazil are flat steel, a product in which CSN is most exposed. This led the company to sell lower value-added products, such as its hot rolled coils (HRC).

Now speaking of figures, the segment sold 1,086 Ktonnes in volume (+2% q/q; +5.1% y/y). It is interesting to note that the sales volume in the domestic market amounted to 732 Ktonnes, down -4.0% q/q and up +9.0% year-on-year. However, the annual increase is linked to the end of the production bottleneck at the Presidente Vargas (RJ) factory, which affected 1Q23.

As a result, the division’s EBITDA was $47 million, down -29.3% q/q and -68.9% year-over-year. In my opinion, given the macroeconomic situation and the aggressive competitive environment, there is no trigger for the operation to contribute again to the result in the short and medium term.

Mining: This was also bad

Companhia Siderúrgica Nacional holds a 79.75% stake in CSN Mineraçãocompany listed on the Brazilian stock exchange, which corresponds to the results of the mining sector.

The deterioration of results was significant in the mining activity, which recorded a net turnover of $560 million, down -43.9% q/q and -31.8% year-on-year. Ebitda suffered a reduction of -59.3% q/q and -45% year-on-year, standing at $223 million.

I was already expecting average results, because Valley (NYSE:VALLEY), the Brazilian giant competitor, had reported an average result. Both companies are dependent on greater economic activity in China to be able to report strong results again.

Logistics and cement – ​​Finally, the positives

Logistics was a positive moment, given the good results of the rail logistics sector and the increase in shipment volume. The Cement division also recorded satisfactory results, with EBITDA +6% Q/Q and +25% YoY, with lower costs and price adjustments offsetting low volumes.

Considerations on the results in general

Overall, I don’t think the company has chosen the right strategy to diversify its business. It’s worth remembering that the reason CSN has much higher debt than its peers is due to the acquisition of companies beyond the steel and mining sector.

An example is the acquisition of LafargeHolcim’s Brazilian assets, in the cement segment, and this is where the company surpassed triple net debt/Ebitda. Even though the segments performed less poorly in the current quarter, high leverage in a cyclical sector does not appeal to me as a long-term investment.

Valuation – Not attractive

At the end of the quarter, the company achieved 3.1x net debt/EBITDA, well above its peers Gerdau (NYSE:GGB) and Usiminas (OTCPK: USNZY) which have the same indicator between 0x and 1x.

When we look at the P/B metric of the company and its peers and take an average, there is no upside potential for stock appreciation. On the contrary, there is a 28% premium, so my recommendation is to sell the shares.

I feel pretty comfortable with the recommendation when I see that Seeking Alpha’s Quant Rating and Factor Grades tools point to the same conclusion.

In other words, I see no benefit in buying stock in a company that faces aggressive competition from Chinese steel, has high debt, and a higher valuation premium than its peers.

Potential threats to the bearish thesis

The risks associated with the thesis have changed little. The reacceleration of Chinese economyespecially in the construction sector, because if this happened, a large part of Chinese exports could be redirected to the local market, without contaminating the market dynamics of countries like Brazil.

The company’s diversification strategy may be correct in the long run. It should be remembered that Companhia Siderúrgica Nacional has higher debt than its peers because it has activities in cement, logistics and energy.

If the medium to long term scenario in the Brazilian steel sector is truly increased competition with Chinese steel mills, the company will be able to make profits in other activities to generate value for shareholders.

The essential

The company trades at a 28% P/B premium to its peers, and even analyzing the EV/EBITDA multiple, there is no upside potential that warrants a change in recommendation.

The risks to this thesis remain the same, as the oversupply of Chinese steel on the domestic market appears far from over. As a result, the company depends on segments like transportation and cement, which are far from representative of overall results.

Based on this analysis, I recommend selling Companhia Siderúrgica Nacional shares. Investors should pay attention to the aggressive competitive environment, high leverage, and low upside potential given the current price.