Companhia Siderurgica Nacional: Still A Compelling Steel Play (NYSE:SID)

Companhia Siderúrgica Nacional (NYSE:SID) (“CSN”), a Brazilian steel conglomerate, followed up a challenging FY22 with an upbeat CSN day presentation. It cited near-term bullishness on the steel cycle, as well as mid to long-term growth opportunities across its business lines. Also positive was the emphasis on maintaining financial discipline (i.e., low leverage levels), as CSN looks to diversify and re-rate the stock over time.

At least in the near term, I largely agree with the bullish take in light of steel demand tailwinds from the post-COVID China reopening. While the uncertain macro backdrop is also a concern for the coming months, management’s emphasis on balancing growth with profitability bodes well for shareholder value creation over the long run. At the current 3-4x EBITDA and ~1.2x P/Book, SID stock is priced very reasonably and offers an attractive mid to high-single-digits % yield to boot.

Bullish Steel Outlook for 2023

CSN had a challenging FY22 amid a steep decline in steel prices – hot rolled coil and rebar prices, for instance, declined >50% from their peak levels. A key driver of the weakness was Chinese property demand, which pulled back alongside the broader economic slowdown and the country-wide implementation of a zero-COVID policy throughout the year. Yet, there have been some positive signs toward the end of last year following the Chinese post-COVID reopening. Somewhat surprisingly, CSN is also pushing a 10% price hike in its domestic market for January, citing the need to maintain import parity premiums. This is in contrast with the company’s margin weakness last quarter, when an outsized -8% QoQ pricing decline outpaced the lower production costs.

Per new guidance for FY23, CSN’s steel volumes are also expected to reach 4,670kt (vs. 4,480kt in 2022), although capex will rise in tandem at R$4.4bn in 2023 before further ramping up to R$5.5-6.5bn/year through FY27. One of the key capex drivers will be the company’s long steel electric arc furnace greenfield project in the U.S., presenting an incremental 350kt/year of capacity by FY26. While the scale of the capex commitment is a concern, incremental cash generation from lower raw materials prices, in addition to demand tailwinds, should help. In particular, the two major global steel markets (U.S. and China) look poised for a better year ahead. In China, the major driver will be the post-COVID reopening, while in the U.S., a potential slowdown (or pause) in rate hikes and easing of supply chain headwinds should boost demand in the key automotive end market. In aggregate, CSN projects the demand side at 14Mt in FY23 – not too ambitious an assumption relative to the 13.7Mt base in FY22.

Non-Core Growth Opportunities in Energy and Logistics

Beyond the core steel business, CSN aims to drive integration across its business lines to lower costs. Investments into the energy business, for instance, are targeted to increase self-sufficiency and create a more predictable earnings stream over time. Thus far, most of the growth here has been inorganic – recent acquisitions have allowed for a significant expansion in installed capacity to >2GW, while new projects such as UFV Floriano should further add to capacity upon completion (current target is >3.3GW). Successful integration will be key in reducing overall costs and is targeted to yield >R$500m in incremental EBITDA gains across all businesses.

Elsewhere, the logistics business will receive a boost from the Transnordestina railroad clearing regulatory hurdles, reinforcing CSN’s verticalization goals. Success here, along with increased international expansion efforts, will help to diversify and reduce the cyclicality of the overall business, potentially re-rating SID stock over time.

Balancing Financial Discipline with Shareholder Returns

While the focus on growth is positive, investors will also draw comfort from management’s emphasis on financial discipline. The CSN financial framework features two key metrics – maintaining low leverage levels and an attractive capital return. The former will be subject to a ~1x net debt/EBITDA target on a through-cycle basis and an upper limit of ~2x net debt/EBITDA to accommodate M&A and downcycle periods. Achieving the target range seems feasible, in my view, supported by CSN’s structurally strong free cash flow (“FCF”) generation. Plus, even with the major LafargeHolcim transaction, the net debt ratio only increased to ~1.7x (trailing-twelve-month).

Separate listings of non-core businesses like cement and energy in the coming quarters present additional support for CSN’s leverage levels. On the other hand, the financial implications of its ESG goals over the next years are unclear – for steel, CSN is targeting a reduction in greenhouse emissions by 20% through 2035 (up from 10% through 2020); the planned acceleration is a risk to the balance sheet.

Still a Compelling Steel Play

All in all, Companhia Siderúrgica Nacional’s investor day will give investors optimism following a disappointing year for the stock price. From the material expansion plans in the energy business to the upside potential in non-core businesses like logistics, CEO Steinbruch is pushing forward with CNS’s renewed growth-focused investment thesis. Balancing growth with financial discipline will be a challenge, but the current low leverage levels and commitment to an attractive dividend payout should help. In the near term, China reopening tailwinds should help steel prices, and even with a potentially challenging economic environment in FY23, CSN’s higher earnings diversification should provide some insulation. With SID stock reasonably priced at 3-4x EBITDA and offering an attractive shareholder return yield, Companhia Siderúrgica Nacional is worth a look.