A Brazilian Steel Producer Expands Its Global Reach

Given the size difference between Gerdau and Arcelor Mittal (which quotes a market cap of $135 billion), Gerdau's capex, which amounted to $1.54 billion over 2007, compares favorably with MT's $5.4 billion. Furthermore, Gerdau anticipates increasing its capex by 36% until 2010, with especially strong growth in such markets as North America (44% capex growth) and Latin America ex Brazil (113% capex growth).

Beyond Latin and North America, the company faces stiff competition, but I believe that at least over the medium term, Gerdau is positioned to be a strong presence in the Americas, especially since its stated policy is that the delivery expense for the customer is limited to freight charges from the nearest competitive mill, with Gerdau absorbing any incremental freight charges.

First Out of the Gate

For a variety of reasons, Gerdau dominates its closest Brazilian competitor. In particular, although SID mines the iron ore that it uses in its mills (about 3.3 million tons last quarter), Gerdau's advantage is that most of its mills operate as electric arc furnace, or EAF, mini-mills, which produce crude steel from raw materials such as scrap steel or pig iron, sourced locally .

And while Gerdau is stepping up its international presence (i.e., principally Latin and North America), SID is retrenching, with its export shipments declining by 41% over the first quarter of 2008 from last year's value, while the company's domestic shipments increased by 55%.

Because of these considerations, and despite SID's higher ROE, I believe the future looks brighter for Gerdau, according to the following table. (GGB's figures are based on the 2007 report, while those of SID are based on the first quarter of 2008, annualized when appropriate.)

Given Gerdau's high capex relative to its market size, high current ratio, strong income growth and relatively high ROE, I believe it has the potential to become your friendly neighborhood steel supplier.

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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.