- U.S. Steel Corporation (NYSE:X) fell sharply in 2018 and 2019. So far, 2020 hasn’t been any better for the stock. The stock has lost almost 8% as of January 17.
- While there are challenges in the steel industry and U.S. Steel faces some company-specific challenges as well, the stock might be ripe for a bounce-back.
- US steel prices have bottomed and have been on an uptrend over the last quarter. Bottoming in the Chinese economy and phase one of the US-China trade deal should also help US steel stocks.
U.S. Steel Corporation
President Trump’s Section 232 tariffs were expected to boost US steelmakers. However, U.S. Steel’s price action tells a different tale. The stock fell almost 50% in 2018—the year that the tariffs were imposed. U.S. Steel stock continued to fall last year even though other steel producers’ stock prices recovered. Before we gauge whether the company is ready for a bounce-back, let’s understand what’s wrong with the stock.
Steel industry’s problem
Since U.S. Steel produces a commodity product, the movement in underlying commodity prices impacts its fortunes. In this case, US steel prices fell sharply in 2018 and 2019. Some of the leading steel-consuming sectors like construction, automobiles, and energy haven’t been in the best of health. The global manufacturing slowdown and the US-China trade war took a toll on metal prices. Notably, steel isn’t an exception. From a sentiment perspective, recession fears kept investors away from the metals and mining sector.
Along with these industrywide challenges, some company-specific problems dragged down U.S. Steel stock. The company is investing massively to revamp its plants, which leads to a cash burn. Also, I think that the company’s management hasn’t been proactive. The company has taken a lot of reactionary measures. For instance, U.S. Steel restarted plants in haste in 2018. Meanwhile, in 2019, the company announced capacity cuts even though US steel prices showed clear signs of bottoming out. The share repurchase plan wasn’t optimal. Instead, management should have repaid debt or kept the cash on hand for upcoming capex needs. Not surprisingly, the stock took a beating in 2018 and 2019. Although the road ahead is still hazy for the steel industry and U.S. Steel, I think that the company looks attractive at this price point.
Does U.S. Steel look attractive?
I’ll discuss five reasons why I think that U.S. Steel looks attractive. First, the Chinese economy has shown signs of stabilization, which should support metal prices. Chinese steel prices have shown strength over the last month, which should trickle down to global steel prices. Phase one of the trade deal, despite all of its shortcomings, clears some uncertainty from the markets. Second, US steel prices have shown strength. Also, mills have announced another round of price hikes. Mill lead times have also been extended, which should support US steel prices. Spot HRC (hot-rolled coil) prices should find support at $600 per ton and might rise more from these levels. While US steel demand growth might continue to be sluggish, the supply side of the equation looks comfortable. With the Section 232 tariffs in place, we should see a structural fall in US steel imports.
Third, markets are punishing U.S. Steel for its cash burn due to the higher capex. Surprisingly, markets rewarded the stock when the company cut down on expenses and capital expenditure under the previous CEO. There was a lower-than-optimal capex. The situation was one of the reasons behind the current spending. In my view, after the ongoing capex and investments, U.S. Steel should be in a better position to compete with mini-mills.
Fourth, I think that the first quarter of 2020 would mark a bottom in U.S. Steel’s earnings. The first quarter is seasonally weak for the company. Beginning in 2021, U.S. Steel should reap the benefits of its current capex plans. While I doubt that the company will get the kind of structural EBITDA benefits that it touted, it should report some benefits after the asset revitalization and other capex plans are completed.
U.S. Steel’s valuation looks reasonable
Finally, the current round of the sell-off started in December after U.S. Steel said that it expects to post a negative EBITDA in the fourth quarter. In my view, the guidance was a bit conservative. U.S. Steel’s fourth-quarter earnings should be better than its guidance. Also, I expect the company’s management to provide a cautiously optimistic outlook during the upcoming fourth-quarter earnings call. Right now, the market sentiments are quite bearish. Even a small earnings beat could lead to a bounce back. Something similar happened after U.S. Steel’s third-quarter earnings release as well.
Currently, U.S. Steel is valued at an enterprise value of a little under $4 billion. The consensus estimates suggest an adjusted EBITDA of around $700 million in 2020, which gives the company a valuation of 5.7x its 2020 expected EBITDA. While the stock looks fairly valued based on the 2020 consensus earnings estimates, the earnings should increase in 2021 as asset revitalization benefits start to pour in.