A Brazilian Steel Producer Expands Its Global Reach

The word is out: Brazilian steel manufacturers are the industry's next global powerhouses. At present, out of total global crude steel production of 1.3 billion tons a year, the Brazilian share works out to be 3%.

Of particular interest for international steel producers is the new Chinese export tax to be implemented as of January 2009, which will restrict Chinese steel exports. Of the two major indigenous steel manufacturers in Brazil, Gerdau (GGB - commentary - Cramer's Take) and Companhia Siderurgica Nacional (SID - commentary - Cramer's Take), Gerdau has the more interesting strategic orientation.

Gerdau manufactures a wide variety of steel products, ranging from rolled steel to slabs, wires and galvanized products. But its strategic focus in its main markets to date - namely, Brazil, North America and to some extent elsewhere in Latin America -- is to set up shop close to customers so it can source raw products more cheaply.

In particular, it is the largest producer of long steel in the Americas, for which it uses its decentralized production process, adjusting the size of plants to meet customer demands, thereby sourcing raw materials locally. Long steel is used for such diverse applications as railroad tracks, wires and structural steel used in buildings. Gerdau's major markets are construction, manufacturing and the ag business.

Additionally, compared with its primarily Brazilian rival, its valuations are more attractive. GGB's and SID's respective P/E ratios are 17.92 and 79.86, compared with sector norms of 21.38. Market caps are equivalent for the two companies, with SID's value at $36.3 billion, slightly higher than GGB's $28.8 billion. The following graph shows that five-year and two-year returns for the company are 94% and 75% respectively, making Gerdau's lower valuations even more impressive.

Click here for larger image.

Source: http://finance.yahoo.com

Operating to Scale

Gerdau is the largest long-steel producer in Brazil, with 47% market share, followed by Belgo Mineira, a subsidiary of Arcelor Mittal (MT - commentary - Cramer's Take). Crucial to any steel company's operations these days is how well the company manages its input costs. Because Gerdau operates in a decentralized manner in its North American and Brazilian markets, it has managed to control its expense growth relative to revenue growth. As a result, its operating margins were reported at 17%, compared with MT's 14%.

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At the time of publication, Vijayraghavan was long GBB.

Vasu Vijayraghavan was an academic finance professor at the University of Paris who has now turned to a new career as a financial consultant. As an academic, she wrote on corporate governance issues, especially in the European context, and she believes in a long-run and balance sheet approach to stock picking.

Currently, Vasu is working as a consultant for lawyers, doing business valuation. She is a Level II CFA candidate and enjoys writing long/short and earnings calls pieces for TheStreet.Com.

Vasu holds a Ph.D. from the University of Michigan and a B.A. from Harvard University.