GGB Upgraded to Outperform - Analyst Blog

We recently upgraded our recommendation on Brazilian steel producer Gerdau S.A. (GGB) from Neutral to an Outperform rating. The company stands well positioned over the long run to leverage the favorable outlook for the global steel market.

Third Quarter Review

Gerdau posted weak third quarter results with a net income down 7% year over year and 28.9% sequentially to R$609.0 million (US$346.0 million). Earnings per share (EPS) were R$0.38 (US$0.22 per ADR), compared with R$0.39 (US$0.0.24 per ADR) in the year-ago period and below the Zacks Consensus Estimate of US$0.28 per ADR. The bottom-line results were negatively affected by higher cost of sales and operating expenses, which more than offset higher revenue in the quarter.

Net revenue was R$8,190.0 million (US$4,653.4 million), up 20% year over year, but down 1% sequentially. The revenue increase was primarily due to higher shipments in the quarter. Crude steel production increased 9% year over year, primarily due to strengthening demand from the automotive industry and reviving credit market. However, steel production decreased 7% sequentially, resulting from correction in the inventory levels.

Gross margins in the quarter were weak at 16% attributable to a 28% year over year and 6% sequential increase in cost of sales, driven by higher raw material costs. 

Detailed discussion on the earnings release can be found here: Gerdau 3Q Plummets, Expenses Soared

Gerdau Upgraded to Outperform Recommendation

We believe Gerdau S.A. is one of the leading Brazilian steel makers and stands at an advantageous position to leverage from the growing world steel market. Global steel demand is projected to increase by 13% in 2010 and 5% in 2011, according to the World Steel Association. The Brazilian steel industry is also expected to get a boost as steel demand from the manufacturing and construction industries grows.

Moreover, Gerdau's growing businesses and increasing self-sufficiency in raw materials (mineral resources) are encouraging attributes. By the end of 2010, expectation is high for Gerdau's annual iron ore production rate, which is likely to reach 2.7 million metric tons, satisfying 50% of the company's iron ore needs. By 2012, the company will be able to internally fulfill all its iron ore needs with an annual iron ore production capacity of 6.6 million metric tons.

The company plans to spend roughly R$11 billion for the period from 2010 to 2014, with roughly 36.4% for the Brazilian operations.

Despite Gerdau's weak third quarter results, hampered primarily by higher raw material costs, we believe favorable outlook for the global steel market warrants better performance in the quarters ahead. Moreover, a positive average earnings surprise of 25.48% for the trailing four quarters is encouraging.

Thus, we upgrade the stock from Neutral to an Outperform recommendation.