Recent Bullishness of Companhia Siderurgica Nacional is Unlikely to Sustain

Summary

SID has failed to deliver any top line growth over the last five years amid lack of demand in the international market

Although SID’s leverage has gone down in recent years, it is still highly over-leveraged

Demand for Steel would decline by 0.8% in 2016, which will likely have a negative impact on SID’s top line in coming quarters

SID has a low price target of $2.2, which means a 20% downside risk to secondary investors based on current market price

Company Overview

Founded in 1941 and based in Brazil, Companhia Siderurgica Nacional (NYSE:SID) is one of the largest and integrated steel companies in the South American market.

While Companhia Siderurgica Nacional is primarily involved in the production, distribution and marketing of flat and galvanized steel, they gradually ventured into several other sectors, including mining iron ore, producing cement, and exploration of limestone and dolomite. Furthermore, Companhia Siderurgica Nacional’s efforts to diversify its exposure has opened the door to enter logistics business, where they operate two railway companies. Companhia Siderurgica Nacional has also made investments in generating energy needs.

Companhia Siderurgica Nacional operates several subsidiaries such as Companhia Metalurgica Prada, Sepetiba Tecon SA, Florestal Nacional SA, CSN Energia SA, Transnordestina Logistica SA, Estanho de Rondonia SA and CSN Cimentos SA to carry out specific operations in different sectors.

Currently, Companhia Siderurgica Nacional’s stocks are traded in São Paulo and New York stock exchanges. As of July 9, 2016, Companhia Siderurgica Nacional had a market capitalization of $3.44 billion and employed around 22,800 people to carry out their operations.

Analysis of Recent Bullish Moves

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Figure 1: YTD, Companhia Siderurgica Nacional’s Stock Price Has Gone Up by 275%

Since the beginning of 2016, Companhia Siderurgica Nacional’s stock price has gone up by 275% as the price spiked to $3.78 per share on April 29. Since then, then stock price has come down a bit, and it is currently trading at $2.75, which represents a 181.8% gain since the start of the year.

Recent Financial Results Do Not Support a Bullish Thesis

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Table 1: Companhia Siderurgica Nacional Quarterly Financials

Over the last ten quarters, Companhia Siderurgica Nacional has lost money, and when they did post a positive result, it was almost near breakeven. Unless, one-time events contributed to a nominal profit, such as in Q4 2015.

Capital Cube did a comprehensive analysis of the company’s performance for the year 2015 and concluded that the improvement in the company’s earnings was not as a result of growth. In fact, the “growth has not come as a result of improvement in gross margins or any cost control activities in its operations.”

Companhia Siderurgica Nacional’s 2015 annual revenue came out at R$ 4587.6, which is less than 50% of its 2011 annual revenue of R$ 9932.73.

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Figure 2: Companhia Siderurgica Nacional Has Failed to Deliver Growth in the Last Five Year Period

Till the start of 2016, Companhia Siderurgica Nacional’s stock price has continually declined in sync with its drop in revenue.

We understand that Companhia Siderurgica Nacional is involved in businesses that requires a lot of capital investments and it is usual for companies like this to have large quantities of long-term debt. Regardless, the management seems to have used a bit too high leverage as the net debt to EBITDA ratio in Q1 2016 came out over 8.

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Figure 3: Companhia Siderurgica Nacional’s Long Term Debt is Still Too High

In this regard, Companhia Siderurgica Nacional has actually improved its long-term debt in the last few years, which has come down to $8.85 in Q1 2016, almost a 100% decrease since      Q1 2012, when it reached over $15 billion.

It was good to see that Paulo Rogerio Caffarelli, the corporate executive director of Companhia Siderurgica Nacional, mentioned during the Q4 2015 earnings call that the management is looking to further reduce the leverage and debt.

Macro Factors and Global Steel Market Outlook

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Figure 4: Brazilian Real Has Depreciated Against the US Dollar in the Last Five Years

Companhia Siderurgica Nacional has the upper hand as one of the most efficient steel producers in the world. In the last five years, the continuous depreciation of the Brazilian Real against the US Dollar has further increased the company’s competitiveness in the international market.

However, the weak demand of Steel in the international market, especially from China, has greatly impacted the industry over the last few quarters. According to the World Steel Association, the demand for Steel will further decline by 0.8% this year, which means organic growth opportunity for companies like Companhia Siderurgica Nacional would be limited.

Conclusion

Regardless of how bullish the market seems to be, the actual micro and macro prospects of Companhia Siderurgica Nacional do not support the recent bullish moves. In fact, after carefully considering several key micro and macro aspects, we believe that secondary investors should take extreme caution while considering to increase their exposure in this Brazilian company.

Currently, Companhia Siderurgica Nacional has the low price target of $2.2, which means secondary investors have a 20% downside risk based on the current market price of $2.75 per share. Given that the dividend forecast for 2016 is virtually non-existent, reducing exposure to this company appears to be the logical conclusion.