Gerdau's Long-Term Prospects Solid, Faces Near-Term Risks

We issued an updated research report on Brazilian steelmaker, Gerdau S.A. (NYSE:GGB) on Jun 19. The company’s long-term growth prospects are bright but exposure to headwinds might restrict its growth momentum in the near term.

In the last one year, the American Depository Receipts (ADR) of this Zacks Rank #3 (Hold) stock have yielded a return of 62.50%, outperforming the gain of 20.85% recorded by the Zacks categorized Steel Producers industry.

We believe that Gerdau’s product portfolio, international diversity and manufacturing techniques will help it grow over the long term. Also, any future investments by the government for infrastructure improvement will boost steel demand in these regions, thereby creating a lucrative market condition for the company. In addition, the world steel demand outlook published by the World Steel Association in Apr 2017 forecasted a strengthening steel demand recovery on the back of improving conditions in developed economies and growth in economies of emerging and developing nations. As revealed in the report, global steel demand is anticipated to grow 1.3% in 2017 and 0.9% in 2018.

Also, we believe that Gerdau’s strategy of disposing loss-making assets/low profit generating businesses will enable it to focus on the more profitable ones. For instance, the company completed the disposition of Spain-based special steel producer to Clerbil SL in 2016 while announced plans to divest its business unit, Premier Thermal Solutions, L.L.C, to Z Capital Partners, L.L.C. in Mar 2017. Moreover in March, the company formed a joint venture with Putney Capital Management to optimize its asset base and improve profitability.

Despite these positives, we believe that Gerdau is exposed to risks arising from higher raw material costs, foreign currency fluctuations and cyclical nature of the industry. Its last reported first-quarter 2017 results were weak. Bottom line in the quarter plunged to a loss of R$34.1 million ($10.9 million) from earnings of R$14.2 million ($3.6 million) in the year-ago quarter. Also, sales declined 16.1% due to forex woes and divestment issues.

Adding to the woes is Gerdau’s highly leverage balance sheet, with roughly R$15.4 billion of long-term debt at the end of first-quarter 2017. Net debt/EBITDA ratio in the quarter was 3.5x. We believe that such high debt levels, if left unchecked will increase the company’s financial obligations and impact its profitability.

In the last 60 days, the Zacks Consensus Estimate for the stock remained stable at 11 cents per ADR for 2017.

Key Picks

Gerdau currently has a market capitalization of $4.88 billion. Some better-ranked stocks in the industry include Schnitzer Steel Industries, Inc. (NASDAQ:SCHN) , Acerinox, S.A. ANIOY and Ternium S.A. (NYSE:TX) . While Schnitzer Steel Industries sports a Zacks Rank #1 (Strong Buy), both Acerinox and Ternium carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Schnitzer Steel Industries’ earnings estimates for fiscal 2017 and fiscal 2018 were revised upward over the last 60 days. Also, the company pulled off an average positive earnings surprise of 73.28% for the last four quarters.

Acerinox’s earnings estimates for 2017 and 2018 improved over the last 60 days.

Ternium S.A.’s earnings estimates for 2017 and 2018 improved over the past 60 days. Also, the company delivered an average positive earnings surprise of 19.98%, over the last four quarters.

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