Pricing Severstal in April 2017

Severstal is a Russian steel company that, like the rest of the sector, has been going through a painful period of declining/flat revenue coupled with pressure on operating margins. The graph below captures the history of Severstal (Get Severstal's full historical data by clicking here):

Note that after an initial period of domestic production and low growth, Severstal embarked on a phase of extraordinary growth combined with profitability from 2004 to 2011, with the company acquiring a global presence. The slowing down of the steel business, starting in 2011, added to the headwinds faced by Severstal, as a result of sanctions imposed on Russia, have resulted in the company shedding some of its non-Russian assets and shrinking back to its profitable Russian base. The key numbers are captured in the table below:

 

To price Severstal in 2017, I looked at how the market was pricing steel companies globally in 2017 and comparing Severstal’s pricing to that of the median company on a number of enterprise value multiples:

Broad Group	Number of firms	EV/EBITDA	EV/Invested Capital	EV/Sales	Return on Capital (ROC or ROIC)	Pre-tax Operating Margin
Australia, NZ and Canada	48	33.62	8.43	21.81	-9.49%	-1.53%
Developed Europe	46	35.05	5.05	3.84	5.43%	4.85%
Emerging Markets	438	53.97	6.01	5.64	4.70%	5.35%
Japan	47	39.20	4.44	3.33	4.06%	4.01%
United States	27	34.82	6.28	4.51	6.33%	2.94%
Global	606	48.92	6.02	6.56	3.65%	4.56%
Severstal	1	27.87	13.48	8.87	47.64%	25.81%
% under or over Global		-43.03%	124.02%	35.25%	1203.75%	466.30%
% under or over Emerging		-48.36%	124.39%	57.13%	913.57%	382.24%

 

Note that while Severstal has a lower EV/EBITDA than the median steel company, it trades at much higher multiples of revenues and invested capital than the median steel company. At the same time, it commands much higher margins and returns on capital.

 

To gauge the relationship of EV/Sales to operating margin, I looked at a scatter plot of the two variables for the 25 largest steel companies:

Note that the regression line fit through the plot indicates that higher margin companies trade at higher multiples of sales and that Severstal (LSE:SVST)  looks under priced, relative to the market, if you control for its higher operating margin (though the under pricing is small). Staying with this sample of large cap steel companies, I ran a regression of EV/Sales against operating margins and expected revenue growth in the next two years:

 Plugging in Severstal's operating margin (25.61%) and expected revenue growth (5.81%) into this regression:

Predicted EV/Sales ratio for Severstal = -1.911 + 0.358 (25.61) + .363 (5.81) = 9.36

At 8.87 times revenues, Seversal looks slightly under valued. The bottom line is that Seversal, even though it trades at higher multiples of revenues and invested capital than the typical steel company, looks slightly under priced because it delivers much higher profitability than the typical steel company.