Gerdau 3Q Plummets, Expenses Soared - Analyst Blog

Brazilian steel producer Gerdau S.A.'s (GGB) third quarter 2010 net income plummeted 7% year over year to R$609.0 million (US$346.0 million) and registered a 28.9% sequential decline. 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.

Revenue

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.

Of the net revenue, Brazilian business accounted for 39.6% and registered a growth of 17% year over year. North American revenue increased 9% and contributed 28.5% to net revenue while Latin American revenue represented 11.2% of net revenue and spiked 18% over the year-ago period. Revenue from Specialty Steel grew 51% year over year and accounted for 20.7% of net revenue.

Crude steel production increased 9% year over year to 4,404 million tons in the quarter 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. Rolled steel production jumped 9% year over year and declined 7% sequentially to 3,628 million tons.

Shipments were strong in the quarter at 4,415 million tons and represented 14% year over year and 1% sequential growth.

Margins

Gross margins in the quarter were weak at 16% down from 21% in the year-ago quarter and 22% in the previous quarter, attributable to 28% year over year and 6% sequential increase in cost of sales driven by higher raw material costs. Selling expenses, as a percentage of revenue, were roughly stable at 1.7%, while general and administrative expenses soared by 30 basis points year over year.

EBITDA at R$1,265 million (US$718.8 million) was down 8% year over year and 26% sequentially with a margin of 15% in the quarter. Operating income was R$781 million (US$443.8 million), down 5.9% year over year and 37.4% sequentially. Operating margin was 9.5% versus 12.2% in the year-ago quarter and 15.0% in the previous quarter.

Balance Sheet

Exiting the third quarter, Gerdau had cash and cash equivalents of approximately R$599.3 million (US$350.5 million) compared with R$1,875.3 million (US$1,041.8 million) in the previous quarter. Long-term debt was R$11,310.4 million (US$6,614.3 million) versus R$12,794.7 million (US$7,108.2 million) in the previous quarter.

Cash Flow

Net cash flow from operating activities decreased 7.8% year over year to R$1,495.3 million (US$849.6 million). Capital spending inched up roughly 1% year over year to R$297.8 million (US$169.2 million). Of the capital spending in the quarter, the company allocated 68% to Brazilian operations and 32% to overseas operations.

Our Take

We believe Gerdau S.A., one of the leading Brazilian steel makers, stands at an advantageous position to leverage from the growing world steel market. Global steel demand is projected to increase by 13.1% in 2010 and 5.3% 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) is an encouraging attribute. By the end of 2010, expectation is high for Gerdau's annual iron ore production rate, which is anticipated 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 satisfy 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.

We currently maintain a Neutral recommendation on the company.