The Long and Short
Valuing Brazil steel producers as tariffs loom
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Emerging markets investors keep waiting for clarity on the potential impact on Brazil from steel tariffs in the US. In the offshore bond market, steel producers such as CSN, Gerdau and USIM are likely affected by whatever tariff structure sustains. Though Gerdau is the largest Brazilian steel company, it has a sizeable US operation and should benefit from potential firmer pricing in the US from re-directed supply. USIM is primarily a domestic producer, with 90% of its production consumed by Brazilian customers and about 20% of its overall exports heading to the US, or only about 2% of revenues. CSN, on the other hand, is relatively more exposed, with about 27% of its steel production exported and the US market approximating 5% of total steel revenues.
While tariffs will likely affect demand and volumes shipped, the overall impact to the production and supply schedule to the US is probably manageable for the Brazilian operators. What is likely more important for the implied valuations of these credits is the indirect impact to steel pricing in Brazil from redirected production to the domestic market. The Brazil steel industry has been in an anti-dumping war with Chinese steel producers for years now. US tariffs will likely exacerbate this, despite the recent protective measures taken by Brazilian regulators with an October 2024 tariff of 25% on Chinese steel exports to the country. Nonetheless, if these latest US government actions hold, Brazilian steel credits are likely to see some increased pressure on local demand and margins. Any additional regulatory protective step by the Brazilian government to increase prices is fraught with unrelated political pressure in a local inflationary environment together with higher local rates.
Recall that President Trump applied a 25% tariff on steel and 10% on aluminum in his first term that substantially affected import volumes before other regions, most notably Europe, retaliated by applying tariffs to goods from largely Republican states such as bourbon, Harley-Davidson bikes and jeans. Over time, steel from the European Union in particular became riddled with exceptions as manufacturers in the US made the case for specific product need in the manufacturing supply chain. The tariffs drove auto manufacturers to lower earnings estimates due to the higher import costs and mainly due to US-based steel manufacturers taking advantage of the tariff by raising local prices without a commensurate increase in production. Thus far, a key difference in this latest tariff salvo is that the 2018 iteration contained duty-free exemptions for Canada and Mexico; this does not appear to be the full scenario this time around, meaning that the volume reduction and local price impacts may be more severe if this latest version is sustained. As such, I would anticipate some valuation pressure on the Brazilian credits and particularly CSN, together with a likely lower average iron ore price in 2025, which has contributed the bulk of EBITDA in recent years.
The recent but now receded M&A risk was an overhang on CSN valuations in 2024, and this year the combination of commodity prices and tariff uncertainty add new layers of risk. However, given the yields above 9% available in the capital stack, the market has been attempting to aggressively price these risks in. The company has maintained its guidance for a deleveraging to 3.0x this year, despite these aforementioned overhangs. However, after a few negative guidance amendments, the market is not giving a high level of credibility to the latest target – despite the potential for monetizing some of the existing asset base by selling minority stakes in business segments. However, if we triangulate valuations across the Brazilian credit space and compare to comparably rated names like Marfrig or Minerva, where there is significant commodity price exposure and margin pressures, the spread differentials have widened by around 250 bp since the beginning of 2024 – adding relative value to the CSN complex.
The relative value in CSN holds in light of recent earnings. Reported consolidated EBITDA was R$3.3 billion, a 46% gain sequentially and slightly below the year-over-year level. This was above the market expectation however, largely as a result of realized iron ore prices, which increased 3.7% sequentially to $61.7 a ton, together with higher volumes in the period: this drove margins at the mining segment to above 50% for the first time since 2022. The mining segment, as a result, accounted for about 60% total EBITDA, with the steel business representing about 30%. CSN Mineração reported EBITDA of R$2 billion, a 77% gain sequentially. The steel business maintained a recent improving trend, with EBITDA of R$656 million a 69% sequential gain, while margin was 10.6% (versus 6.4% in the third quarter of 2024), on the back of a 1% increase quarter-over-quarter sales volumes, a better sales mix and enhanced COGS a ton (-3% quarter-over-quarter). We note that the positive trend is anticipated to continue in Q125, given the 5% price increase that was pushed through in January. The Cement business reported an EBITDA of R$386 million, for a 10% sequential gain, while margin was 32.8%, versus 27.5% in the preceding quarter, mainly as a result of continuing cost control initiatives. During the quarter, CSN spent R$2.1 billion on capex, compared to R$1.3 billion in the third quarter of 2024, which was about in line with previous guidance for the full year, incorporating the spend level to progress in the construction of CMIN’s P15, as well as improvements in the steelmaking, sintering and modernization of operations at UPV. Together with working capital cash usage (on the back of higher prices), FCF was a consolidated burn of R$1.75 billion, meaning that in 2024, the Company burned about R$5.5 million in total – underlying the incremental challenge in reaching deleveraging targets, which in the most recent quarter was further inhibited by BRL devaluation that more than offset the improved operating results. As a result, net leverage ticked higher again to 3.49x, from 3.34x in the third quarter of 2024 and 2.58x in the corresponding period last year.
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