by Susan J. Aluise | April 26, 2012 8:48 am
“A man always has two reasons for doing anything,” U.S. Steel’s (NYSE:X) founder J.P. Morgan once said. “A good reason and the real reason.”
The famed financier and industrialist’s words still apply to steel stocks 111 years later. New forecasts indicating the industry is on the verge of a revival qualify as a good reason to buy; but the real reason is the opportunity to buy quality steel stocks at bargain prices.
U.S. Steel, which reported first-quarter earnings on Tuesday, posted a loss of $219 million ($1.52 a share) on revenue of $5.2 billion — far worse than the $86 million loss in the same quarter last year. While those numbers seem ugly on the surface, they distort the picture because they include a $399 million loss the company took selling U.S. Steel’s Serbia plant back to that country’s government for $1.
Excluding that charge, X earned 67 cents per share — beating Wall Street estimates of 44 cents per share on revenue of $4.9 billion. U.S. Steel’s 6.3% sales growth in the quarter in particular is a good sign that the steel industry is beginning to turn the corner from the abysmal performance it has suffered since the global economy hemorrhaged in 2008. Still, the stock traded down 2% on the news Tuesday.
Dirt-cheap natural gas prices were a huge positive for the nation’s largest steel producer as U.S. Steel was able to use more natural gas in steel production. The more X and other steel companies can displace the use of expensive coking coal for iron-ore smelting operations, the better their margins will look — at least in the short term. Using natural gas to fuel these operations has the added benefit of reducing greenhouse emissions.
AK Steel (NYSE:AKS) also reported quarterly earnings on Tuesday, but pricing pressure and a gloomier outlook for the second quarter weighed heavily on the stock, which also slipped nearly 2%.
The steel industry’s recovery — like that of the world economy — faces short-term headwinds, such as a slowdown in China’s economy, excess global steel inventories and rising raw materials costs. Europe also remains a near-term weakness. Still, the most recent steel industry data indicates trends are moving in the right direction. U.S. steel mills shipped 8.4 million net tons in February — more than 20% higher than in the same month last year, according to the American Iron and Steel Institute.
Although the industry’s full recovery may be a couple of years away, there’s one real reason to buy the right steel stocks now: They’re available at bargain-basement prices. So here are three steel stocks to buy for the sector’s recovery – and for the bargain:
Despite the short-term headwinds, there are some significant bright spots for U.S. Steel to build on. The company’s operating income in the first quarter was $295 million, compared to only $4 million for the same quarter last year. Prices increased by $23 per ton to $764 per ton and shipments also rose to 4.1 million net tons, the highest level since the third quarter of 2008.
Analysts believe X will post second-quarter revenue of a hair over $5 billion with EPS of 81 cents, reflecting the industry’s short-term headwinds. But the consensus estimate for next year is an EPS of $2.66 on surging revenue of $19.7 billion. If it delivers, the stock should see a big bounce.
At around $28, X still is trading 46% below its 52-week high last April. U.S. Steel currently trades at 1.2 times book and 0.2 times sales — both indications the stock is undervalued. It also has a forward P/E of 7, indicating an expectation of higher earnings growth.
There’s no sugar coating the facts — the nation’s second-largest steel producer struggled with softer prices and weaker margins in the first quarter, largely because of sluggish construction markets and cheaper imports from China. Last week, Nucor (NYSE:NUE) reported earnings that had slipped more than 9% from the same quarter last year.
But those numbers don’t tell the whole story. Stronger sales in the vehicle manufacturing and energy sectors are giving NUE a boost on production and shipping volume as well as price. Analysts expect the second quarter to be fairly soft, with $5.3 billion in revenue and an EPS of 76 cents. But they’re bullish about next year, forecasting an EPS of $2.75 on nearly $21 billion in revenue.
At around $39 today, NUE is still 17% below its 52-week high. The stock has a P/B ratio of 1.6 and a P/S ratio of 0.6 — though its forward P/E is on the high side at 17. On the upside, NUE does offer an attractive 3.7% dividend yield.
Like X and NUE, Luxembourg-based ArcelorMittal’s (NYSE:MT) earnings and share prices shriveled up when the global economy went south. As a European company, MT is feeling the pain of the sovereign debt crisis and EU recession more acutely. It also has a lot of debt — more than $26 billion, compared to less than $4 billion in cash.
ArcelorMittal is the world’s largest steel producer — but it’s also the fourth largest iron-ore mining company. That’s why low raw materials prices are a significant challenge to current earnings and margins and likely will continue to be pressured for the next couple of quarters.
Still, analysts are bullish about the future of MT, which next reports earnings on May 11. They estimate EPS of $1.95 this year to grow to $3.18 next year. Revenue also is expected to grow about 6% in 2013 to $98 billion. However, the best argument for MT is in the cyclical nature of the sector. Sooner or later, China’s manufacturing will get a second wind, Europe will get off the schneid and iron ore prices will rebound — and this undervalued stock will start to soar.
At around $16.50, MT still is 55% below its 52-week high. The stock trades at 0.5 times book, 0.3 times sales and 9 times forward earnings. And like Nucor, ArcelorMittal offers an attractive 3.7% yield.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.
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