SID Downgraded to Underperform - Analyst Blog

We recently downgraded our recommendationfor Companhia Siderurgica Nacional (SID) or CSN, one of the leading Brazilian steel makers, from Neutral to Underperform.

Third Quarter Highlights

On October 28, Companhia Siderurgica Nacional announced its financial results for the third quarter of 2010. The company's net income plunged 37% year over year and 19% sequentially to R$720 million (US$409.1 million), or R$0.48 per share (US$0.27 per ADR). Earnings results lagged behind the Zacks Consensus Estimate of US$0.36 per ADR.

The weak net results were primarily due to higher manufacturing costs and an increase in effective tax rate.

Net revenues of R$3,948.8 million (US$2,243.6 million) soared 32% year over year and inched up 2% sequentially. The year-over-year growth was primarily due to a 23% increase in net revenue per unit, offset partially by a 10% decline in sales volume sold.

Crude steel production increased 5% year over year and 3% sequentially to 1.23 million tons. Steel sales volume plummeted 10% year over year and 8% sequentially to 1.2 million tons, of which domestic sales accounted for 86.6% and exports around 13.4%. Rise in domestic sales volume of 16.6% was more than offset by a 63.3% decline in export sales volumes.

Downgraded to Underperform

We believe the growth prospect of Companhia Siderurgica is encouraging due to various projects being carried out by the company. Entrance into the cement business seems to be an added advantage.

According to the World Steel Association, global steel demand in 2010 is likely to increase by 13.1% in 2010 and 5.3% in 2011. This enhancement is based on recovering economics, increasing private and public capital spending, falling unemployment levels and growth of the emerging economies, especially China and Brazil.

Despite these positives, the growth momentum gets restricted due to expectations of weak results in the quarters ahead as de-stocking process in the Brazilian steel market will lower domestic shipments (87% of sales) and induce exports. Moreover, rising manufacturing cost remains a cause of concern.

Mounting debt level, high cyclicality and growing competition in the industry will also act as impediments to growth. Based on all this and anticipating a lack of any positive share price driver, we downgrade our recommendation on SID to Underperform from a Neutral rating.