Should You Buy U.S. Steel After the Big River Acquisition?

U.S. Steel Corporation (X) stock has gained sharply in 2020 and is trading at multi-year highs. The stock has more than tripled from its 2020 lows. In a previous article in March, we had noted that U.S. Steel stock looks like a buy for investors willing to withstand the short-term volatility. A lot has changed for X since then including its acquisition of Big River Steel. Is U.S. Steel stock still a buy or should investors consider booking profits at these levels?

U.S. Steel had announced the Big River Steel acquisition in 2019 and purchased a major stake. It has now purchased the remaining stake in the company. The acquisition is part of X’s “Best of Both” strategy.

Historically, U.S. Steel has produced all its steel in traditional blast furnaces. Over the years, competitors like Nucor and Steel Dynamics have put their weight behind minimills that run on electric arc furnace (EAF) technology. In a blast furnace, iron ore and coke are the key raw materials while minimills primarily use steel scrap or alternatives like direct reduced iron (DRI) and hot briquetted iron (HBI) along with electricity.

EAFs have a variable cost structure and adjust better to suit production levels. That’s a competitive advantage over blast furnaces, which have higher fixed costs. Blast furnaces also require spending money on plant maintenance to keep the plant “hot idled” during a short-term curtailment.

X took cognizance of its over-reliance on blast furnaces and came up with its Best of Both strategy. It went about modernizing its aging blast furnaces while at the same time investing in new EAFs. Big River Steel produces steel in modern EAFs that fit perfectly into that strategy.

With Big River, U.S. Steel increases its EAF footprint and adds new flat rolled capacity. Big River’s mills are among the newest and advanced mills and should have a lower cost structure than some of U.S. Steel’s plants. Also, the plant produces advanced high strength steel (AHSS) products, which are value-add products used by the automotive industry. Value-added products have higher margins and face less competition from imported products as compared to commodity-grade metal products.

According to the estimates compiled by TipRanks, X stock’s average price target is $9.86, which is a downside of almost 48 percent over current prices. One of the reasons the stock is trading way above its target price is because of the recent runup. Analysts target prices tend to lag the price action, more so when it comes to metal and mining companies.

To understand whether you should buy U.S. Steel stock, it is prudent to look at the pricing environment — a key driver for metal producers. According to CRU data, December hot roll coil (HRC) futures trade at $850 while the January future quotes at $950. That’s a multi-year high for HRC prices which is seen as a benchmark for other grades also.

Next year, we could see an increase in U.S. steel demand as the economy continues to recover. Demand for metals like steel closely correlates to the underlying economic activity. Another aspect to consider would be the consolidation in the U.S. flat-rolled market. While X has acquired Big River, a flat steel producer, Cleveland-Cliffs has acquired AK Steel as well as ArcelorMittal’s U.S. assets. The market consolidation is good for the pricing environment and would help U.S. Steel.

Looking at the valuation, X stock trades at an next-12 months (NTM) enterprise value to revenue multiple of 0.76x. Analysts expect the company to post a loss in 2021 and hence its NTM PE multiple is in the negative. However, Wall Street analysts haven’t yet factored in the sharp rise in steel prices—both in the U.S. as well as globally—that would drive the earnings next year.

X stock looks like a buy even after the recent rise. Along with the rise in steel prices, the company is expected to benefit from structural cost savings beginning in 2021. Also, we could see higher spends on infrastructure under a Biden presidency, which w ould lift demand for U.S. steel companies. However, if Biden repeals Trump’s steel tariffs, it could be a short-term negative for the domestic steel industry.