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Are Steel Companies’ Premium Valuations Justified?

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Valuations

Valuation multiples are a key metric that smart investors consider. With the help of relative valuations, we can assess a company’s valuation with respect to its closest peers’ valuations. There are several valuation metrics that we can use in such valuations.

For companies in cyclical industries like steel, EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation, and amortization) is the preferred valuation metric. The forward EV/EBITDA multiple tells us how a company is valued for each dollar of EBITDA.

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Premium valuations

The graph above shows forward EV/EBITDA of different steel companies. U.S. Steel (X) is trading at a substantial premium to its long-term trading multiples. Nucor (NUE), Steel Dynamics (STLD), and AK Steel (AKS) are also trading at a premium to their long-term trading multiples.

However, it’s important to note that for commodity (GCC) companies, valuation multiples tend to peak when the economic cycle is about to take a turn for the better. Markets start factoring better forward earnings before analysts upgrade their earnings guidance, and we tend to see analyst upgrades for earnings coming after stocks rise from the depths.

Earnings

Analysts have already started to revise upwards the forward earnings estimates for steel companies on expectations of higher steel prices. However, as we have explored in the course of this series, a major recovery in steel prices might not happen.

The valuation multiples might start to look bloated in the coming months if earnings don’t support stock prices. The 1Q16 earnings season will be a key test for US steel companies to justify the stock price surge.

You can follow the earnings of major US steel companies by visiting Market Realist’s Steel page. You can also read Is the Steel Industry Really Turning Around? to find out more about the challenges facing the global steel industry.

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