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Gerdau SA (ADR) (GGB), Vale SA (ADR) (VALE), Companhia Siderurgica Nacional (ADR) (SID): Invest In These Three Brazilian Steel Companies

Low labor and raw material costs provide Brazil’s foundries and metal producers with an advantage over worldwide competitors. Furthermore, several international sports events coming up in the next three years will certainly boost the demand for metals, as huge infrastructural projects are undertaken by the state. The Brazilian Steel Institute expects sales to increase by 7.7% in 2013. Three companies in particular, Gerdau SA (ADR) (NYSE:GGB), Vale SA (ADR) (NYSE:VALE) and Companhia Siderurgica Nacional (ADR) (NYSE:SID), deserve a closer look, as their upside potential is substantial.

Gerdau SA (ADR) (NYSE:GGB)

A market leader

Not only is Gerdau SA (ADR) (NYSE:GGB) a leader for steel production in Brazil, but also the second largest in the world. It operates 59 production units, both locally and overseas, in other South American countries as well as in North America, Europe, and Asia, and has a history of over 100 years of consistent profitability. Geographically diversified, the company can stand weak domestic demand levels, as international exposure has tended to balance this trend.

Its model is quite interesting: the company uses mini-mills to process scrap metal, turning it into steel. This helps it face the cyclicality of the industry by reducing costs and operating leverage (Morningstar).

Furthermore, the firm counts with a high level of vertical integration and owns a stake in iron ore mines and distribution, coke production, and scrap recycling. This reduces both its raw material costs and its dependence on third party providers. Moreover, according to Zacks analysts, iron ore mines are expected to produce 11.5 million tons in 2013 and reach 18 million tons in 2016.

Despite a weak first fiscal quarter, the outlook seems pretty encouraging. Brazil will host the 2014 FIFA World Cup and the 2016 Olympic Games, thus facing huge infrastructural developments that should provide the steel industry with a considerable demand momentum. Moreover, the demand of steel should increase further as farming techniques and infrastructure are undergoing a modernization process in the country. Consequently, the firm is focused on rising production levels and finishing a major production facility by 2020. Emerging economies provide even further growth opportunities, and the firm has invested heavily to face the increasing demand in Japan, India, and the U.S.

Trading at only 6.5 times its earnings while expecting an average annual growth of almost 12% for the five upcoming years, about ten times its peers’ mean, I would advocate buying this stock. Even despite its volatility (beta is 1.94), I believe that the current is a good entry point for a company that is poised to grow in the years to come.

A good pick

Unlike other big diversified miners, Vale SA (ADR) (NYSE:VALE) focuses on iron ore production, which accounts for 70% of sales and 90% of EBITDA. Although this has made the firm widely dependent on the segment, it has also provided it with the most valuable iron ore franchise in world, producing about 20% more volume than its closest competitor, Australia’s Rio Tinto, and almost double the third-runner, BHP Billiton (Morningstar). Nevertheless, its subsidiary businesses are not to be under-appreciated; its mining segment is important and has registered considerable volume growth, especially in the coal production. Last quarter, the firm reported an increase of 17% year-over-year in its coal production levels. Its logistics are also to be highlighted: its integrated railroad and marine terminal system saves plenty of money for the firm and, in addition, generates about 7% of the firm’s total revenue.

Just like Gerdau SA (ADR) (NYSE:GGB), Vale SA (ADR) (NYSE:VALE) enjoys lower costs than most of its peers. As such, it is better positioned to face the cyclical and volatile nature of the industry, as well as to benefit from the expansion of global steel demand, expected at 3.2% for 2013 (World Steel Association), and the local steel demand, which should experience momentum as the World Cup and the Olympics get closer. Furthermore, expanding demand of steel in emerging markets like India, China, and Southeast Asia should drive growth in the years to come.

Several cost-reduction initiatives should take earnings figures even higher. Last quarter, the company reported a 27% decline in expenses relative to the previous quarter, and will continue to save money by selling off its less-profitable assets.

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