Gerdau S.A. (NYSE:GGB) is an international steel operator operating out of Sao Paulo, Brazil. It offers its steel-based products across a range of industries such as the auto industry, the construction industry, the agricultural industry, as well as the oil and gas industry. Gerdau’s fortunes have changed in recent months as demand has returned to many of the industries which it services. The energy and agricultural industries, for example, (despite their recent rallies) remain heavily oversold on their respect multi-year long-term charts. As both of these asset classes continue to rally, these trends should be favourable for Gerdau.
Since plenty of Gerdau’s operations as well as the lion’s share of its debt are in US dollars, this is another area where Gerdau could see gains going forward. The Brazilian real has been on a downward spiral against the dollar for the best part of a decade now. However, the pandemic was not kind to the dollar, and the real remains well up from its May bottom of 0.169 to the USD. Suffice it to say, if the real can take out its June high of 0.207, it would go a long way to declaring the bear-market over for the real.
The company reported $0.03 in earnings per share in the second quarter this year and then subsequently $0.08 in the most recent third quarter. Momentum is expected to continue as $0.12 is the bottom-line number expected for the fourth quarter. If the fourth-quarter bottom-line number is met, Gerdau will have increased its earnings by well over 50% in 2020. The good thing from an investor’s standpoint is that growth is expected to continue into 2021 (45% expected bottom-line growth)
At present, Gerdau trades with a book multiple of 1.3 and a sales multiple of 1.0. These numbers are well over Gerdau’s five-year averages but are much closer when we span the averages out to 10 years, for example. As we can see from the monthly chart below, the sharp rally in the share price this year, along with the rally out of the 2015 lows, has resulted in the 50-month moving average now firmly turned up. This has not happened in Gerdau for quite some time.
Our followers will know that we like to follow the flow of cash through a business. The reason being is that we are more interested in the conditions which can create sustained earnings growth instead of how earnings have been trending themselves. Top-line sales grew by over 23% in Brazilian real terms in Q3, and EBIT grew by 87.5%. Gerdau has been making excellent progress on its cost-cutting initiatives, with SG&A coming in at 1.4 billion BRL for the past four quarters. Remember, top-line sales have only come down approximately 1.4% on average over the past 5 years, but SG&A is down 45%. This is a solid achievement for the following reason.
From a sustainable standpoint, we want as much as that EBIT dropping to bottom line as much as possible. For example, interest expense of 953 million BRL over the past four quarters continues to come down but remains just over 30% of what the firm is generating in operating income. The faster costs can continue to come down, the more operating income can drop to the bottom line, which is beneficial for asset accumulation in the long run.
The almost 800 million BRL of net income reported in Q3 means Gerdau has done 1.43 billion BRL in net profit over the past four quarters. This number drove cash through the business as 3.65 billion BRL of operating cash flow was generated during the same time frame. This amount of cash flow was ample for investing purposes (1.67 billion BRL) and financing (588 million BRL). In fact, 1.88 billion BRL of cash was added to the cash balance over the past four quarters along with 1.94 billion BRL of free cash flow. Cash flow trends such as the above are why shareholder equity rose by almost 4 billion BRL in Q3 over the same quarter of 12 months prior.
When we research the balance sheet more closely, we see that long-term debt continues to rise, and over 20% of the firm’s assets are made up of goodwill and intangibles. Management has stated that it will continue to do everything possible to bring down the debt load through higher profitability and more cost cutting. We have yet to see, though, this declaration show up in the numbers.
Therefore, to sum up, at present, Gerdau is generating plenty of cash on the back of solid demand. Earnings are growing, and momentum is set to continue into 2021. Shares look fairly valued, and book value is growing. The one area of worry is the rising debt on the balance sheet. This debt looks meaningful when compared to annual earnings, for example. Let’s see what the fourth quarter brings.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.