We recently downgraded our recommendation for Companhia Siderurgica Nacional (SID) or CSN, one of the leading Brazilian steel makers, from Neutral to Underperform.
Second Quarter Highlights
On August 10, Companhia Siderurgica Nacional announced its financial results for the second quarter 2010. Net income surged 167% year over year and 85% sequentially to R$894 million (US$496.7 million), or R$0.59 per share (US$0.33 per ADR). Earnings per ADR were in line with the Zacks Consensus Estimate of $0.33 per ADR.
The sequential rise was attributable to higher volumes combined with higher prices of iron ore and steel products and lower interest expense, which more than offset increases in income tax and social contribution expenses in the quarter.
Considering the top line, net revenues of R$3,872.6 million (US$2,151.4 million below the Zacks Consensus Estimate of US$2,184 million) climbed 55% year over year from R$2,491.7 million (US$1,192.2 million) in the year-ago quarter. The growth was due to higher prices and volumes sold.
Crude steel production in the quarter soared 38% year over year to 1.2 million tons versus 0.9 million tons in the year-ago quarter. Steel sales volume improved to 1.3 million tons, registering an increase of 37% year over year. Of the total steel volume sold, 88.5% accounted for domestic sales and the rest international sales. Price for steel products per unit went up 6% year over year.
During the quarter, manufacturing costs increased 18.9% year over year to R$1,784.8 million (US$991.6 million). Loans, financing and debentures, net of current portion were R$16,472.4 million (US$9,151.3 million), up 12.2% from R$14,684.5 million (US$8,158.1 million) in the previous quarter.
Downgraded to Underperform
We believe the growth prospect of Companhia Siderurgica is encouraging due to various projects being carried out by the company. Moreover, its entrance into the cement business would be an expected synergy. According to the World Steel Association, global steel demand in 2010 is likely to hike by 10.7% and 5.3% in 2011. This enhancement is based on economic recovery, increasing private and public capital spending, falling unemployment levels and growth of the emerging economies, especially China.
However, the quarters ahead are likely to be less promising and more depressed, attributable to falling domestic sales and higher manufacturing costs. High inventory levels in the supply chain will force steelmakers to export more leading to lower domestic sales (88.5% of sales). Also, CSN’s debt levels are escalating, ascribed primarily to funding the company’s dividend payments and investment plans. Moreover, high cyclicality and growing competition in the industry are major hindrances to growth.
Based on all this and anticipating lack of any positive share price driver, we downgrade our recommendation on CSN to Underperform from a Neutral rating.