Companhia Siderúrgica Nacional

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Companhia Siderúrgica Nacional (SID), a Brazilian steel company, is vertically integrated and involved in iron ore mining, steel production, cement production, logistics, and energy generation.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Competitive Landscape

Companhia Siderúrgica Nacional (CSN), operates primarily in the steel sector, with a significant presence in iron ore mining. These core segments are essential to global infrastructure development and have been experiencing increased activity and growth in recent times. They are supported by integrated logistics for iron ore and steel products.

CSN’s revenue is largely driven by its steel segment. This segment includes the production and sale of various steel products and related raw materials. The company’s vertically integrated approach from mining iron ore to distributing steel products provides it with some control over its supply chain, potentially providing a competitive advantage during times of supply chain issues.

Recent reports suggest a positive outlook on the global steel industry, with expectations for demand growth in the near term, particularly driven by increasing infrastructure spending, especially in Brazil.

  • Steel: The company produces a range of steel products, including flat and long steel.
  • Mining: CSN is involved in the extraction of iron ore, a crucial input for its steel production, and also has its own mines.
  • Cement: CSN manufactures cement, a vital product in construction projects, and also offers some construction aggregate products as well.
  • Logistics: Involves transportation of the company’s products and third-party goods.
  • Energy: The company engages in power generation, which supplements its operations. The power generation facilities are not related to external sales.

The markets they serve are global, including a presence across South America, Asia, and North America. They have been focusing on expanding their offerings to high-end products with the aim of higher profitability and a growing presence in new markets.

Financials Deep Dive

From 2019, there has been a significant increase in the company’s revenue, while at the same time their EBIT and net income have experienced severe volatility due to changes in the business cycle and other external factors, also the impact of goodwill impairments and foreign exchange rate shifts.

  • Revenue: For fiscal year 2022 total consolidated revenue was 55,093 million in Brazilian Real, 32% higher than prior year revenues of 41,648 million. The higher revenue was driven mainly by increased prices in steel and iron ore. This resulted in a net income for the period of 7,707 million BRL, which, although positive, is down considerably from the previous year’s net income.
  • EBITDA The EBITDA, as reported in December 2022, was 14,865 million BRL. The EBITDA margin was 26.98% a huge drop compared to the 50.12% reported in fiscal year 2021. As previously mentioned, the drop in earnings and margins were caused by increases in production costs which offset the increase in sales.
  • Operating Expenses: The company reported operating expenses of 48,048 million BRL for fiscal year 2022, increased as compared to prior year’s operating expenses. The largest increases were in Cost of Goods Sold (COGS) and administrative expenses.
  • Cash Flow: Cash from operations for FY 2022 was at 10,902 Million BRL, this was much lower compared to the reported 21,094 million from previous year. This was due to the drop in net income because of the increased production costs. The cash from operations is being heavily affected by fluctuations in the business cycle.

Moat Analysis

CSN possesses a very narrow moat rating of 2 out of 5 due to a couple of reasons but primarily because of their control over some of the raw material used in their production process. These are:

  • Vertical Integration: The company’s vertical integration and ownership of iron ore mines can be beneficial during supply shortages and can be a source of cost advantages, but it is not a wide advantage since many players in the market have a similar structure.
  • Economies of Scale: Scale in production allows them to produce in large quantities, leading to cost benefits, but it is not an unreplicable process.

The majority of CSN’s business is in the commodity sectors, both for steel, iron ore, cement and energy. In commodity sectors pricing power is low and the biggest competitive factor is cost advantage. And while CSN does have some competitive advantages, they are not unreplicable and therefore provide very narrow moat.

Risks to Moat and Business Resilience While CSN has a few points of strength, many external risks could affect their business and erode the moat.

  • Commodity Price Volatility: Fluctuations in iron ore and steel prices can impact profitability. Prices of iron and steel and other commodities are primarily influenced by global demand and supply, which are external factors beyond the management’s control. The company might have long-term contracts at low prices which might impact their ability to take advantage of the current high prices.
  • Exchange Rate Exposure: A significant portion of their sales are in foreign markets and their revenue is dependent on prices in their home currency, a change in the exchange rate can adversely affect their profits. There is a big risk if the Brazilian real appreciates too much against other global currencies.
  • Competition: The global steel industry has many large competitors and the competitive intensity may erode potential margins. Specifically competition from Chinese and Korean steelmakers is a growing concern.
  • Economic Downturns: As with any basic materials company, CSN’s performance and revenue is heavily reliant on global economic conditions. Slowdown in the construction, infrastructure, or consumer goods industry might lead to reduction in the demand for steel and cement, affecting the company’s sales and profits.
  • Operational Issues: There are several regulatory hurdles and logistical challenges that affect all players in the raw material sector. Production constraints might impact their production and costs. WMS had a major operational error in their systems a few years ago, and they had to shut down their operations as a result. Similar issues might lead to drastic reduction in production, sales, and profits.
  • Debt levels The company carries a significant amount of debt on the balance sheet. While the company does have plans to pay this off, any negative change to the overall economic scenario or their internal business might lead to inability to repay the debt and financial distress.
  • Cost of funding The company has a substantial amount of its debt in USD, while its assets are primarily in BRL. In the case where the BRL depreciates quickly against the USD, this can lead to an increase in their interest burden. Moreover, if interest rates increase, the company may face higher costs to borrow, reducing their overall profitability.

CSN does have some degree of resiliency. Their vertical integration and control over their raw materials does provide them some control and might lead to better costs. Their strong presence in the Brazilian markets with good reputation also gives them an edge over competitors. But if a significant economic downturn or industry specific disruption were to occur, the company might struggle in the short to medium run.

Understandability

CSN’s business model is rated a 3/5 in terms of understandability. While some components like steel and iron ore are easy to understand, the complexity arises from its vertical integration and multiple segments, the impact of global macroeconomics on the commodity industries, and their financial structuring, and multiple regulatory environments make this slightly harder for an average investor to grasp.

Balance Sheet Health

The balance sheet health is rated a 3/5.

  • Positive Signs: Current assets are higher than current liabilities giving some room for any immediate needs. The current ratio is good but not exceptional. The company has substantial amounts of inventory, which is typical of commodity producing companies, but this does mean that the company needs sufficient demand to sell these inventories profitably.

  • Negative Points: The company carries a substantial amount of debt on its balance sheet and the net debt is more than twice their yearly revenue. They have not been able to create enough free cash flow in the last 5 years to offset this. While the company is slowly lowering their overall debt, their long term debt is still more than twice their shareholders’ equity. Also, the company is exposed to a significant financial risk arising from sudden shifts in foreign exchange rates. The company has a history of using complex financial instruments and derivatives which creates financial uncertainty.

Overall, while the company is not immediately facing a risk of bankruptcy, its balance sheet is not in the healthiest condition and any major operational disruption or negative market trends might put a strain on the finances.