Lower import tax breaks could boost domestic steel prices and provide a lifeline for embattled producers like Usiminas (USNZY, quote), Gerdau (GGB, quote) and Siderurgica Nacional (SID, quote), if analysts at leading Brazilian investment bank Itau BBA are right.
“Despite not having a positive view on the Brazilian steel sector because of valuation, we believe that the sector could gain momentum in 2Q12, fueled by potential increases in domestic steel prices and a light technical position, with most investors either neutral or negative on the sector,” Itau analysts point out in a new research note.
The catalyst: the Brazilian senate is talking about approving a resolution to equalize the international value-added tax (VAT) at 4%, effectively eliminating a tax break that foreign steel makers currently enjoy.
Given unprecedented support from the main political parties, Itau thinks the measure is likely to pass in the near term.
As it is, according to distributors and commodity traders, pricing on domestically produced long and flat steel is almost identical to what importers from Asia can support.
Enforcing the 4% tax on foreign steel will help keep local product competitive in terms of price and may actually open a window of opportunity for producers to raise prices and keep ahead of the cost of labor, raw iron and coal.
By the Itau research team’s calculations, long-suffering USNZY would benefit the most from the change in the VAT tax scheme, with a hypothetical 6% increase in domestic prices boosting its 2012 EBITDA by 38%.
For GGB and SID, the impact on EBITDA would be 14% and 8%, respectively, reflecting these companies’ relatively balanced global businesses and correspondingly less concentrated exposure to the domestic steel market.
Still, while Itau is interested in the impact that higher prices can have on these companies’ bottom lines, the analysts acknowledge that the profit boost will only soothe the pain for most of the Brazil steel group.
GGB, for example, is trading at a relatively rich 14.9 times earnings and yields barely 1.90%.
SID, on the other hand, is now roughly comparable to its slightly larger rival in terms of liquidity and market cap, but is still valued at just under 7 times earnings — half of what GGB will cost traders on a fundamental basis — and pays a 6.90% yield.
And as for relatively thinly traded Usiminas, the company’s deteriorating results have pushed the P/E up beyond 50, well beyond levels where any but speculative traders dare to tread.