The Best Way to Play Surging Steel Right Now

Steel stocks rise on cost cuts, stronger European demand

   
The Best Way to Play Surging Steel Right Now

It has been a wild and wonderful week for steel stocks as positive earnings surprises from U.S. Steel (X) and AK Steel Holding (AKS) sparked strong gains. Although the global steel sector is picking up steam as demand grows in Europe and the U.S., ongoing challenges in China and other headwinds make it all the more important for investors to choose wisely.

16003501 solid steel aluminum plates 150x150 The Best Way to Play Surging Steel Right Now
Source: iStockphoto

The good news: global steel use will grow by 3.1% in 2014, according to the World Steel Association. Stronger than expected growth in U.S. demand — combined with a slight recovery in Europe — helped offset a slowdown in China. The association expects U.S. demand, which registered a slight decline in 2013, to grow 4% this year and 3.7% in 2015.

The bad news: Europe’s recovery is weak, China’s debt challenges will continue in the short term, and geopolitical risk looms in many emerging economies. Not even the U.S. is immune to potential headwinds if the economy stumbles or the Federal Reserve’s “tapering” ramps up and poses a risk to growth.

Let’s recap the earnings news for steel stocks: U.S. Steel stock soared by a whopping 19% on Wednesday after quarterly earnings that were far better than expected. U.S. Steel earned 17 cents per share in its fiscal second quarter on $4.4 billion in revenue, blowing away the 31-cent loss on $4.2 billion in sales that Wall Street expected.

Although demand began to strengthen in Europe, U.S. Steel’s strategic cost-cutting plan delivered the results. Dubbed the Carnegie Way (a tribute to U.S. Steel founder Andrew Carnegie), the plan will pare some $435 million in costs this year alone.

Rival steel stock AK Steel climbed nearly 8% after Tuesday’s earnings beat. Adjusted earnings of 2 cents a share on $1.53 billion in revenue beat the Street’s expectation of a 4-cent loss on $1.51 billion in revenue. The gains stemmed primarily from a 5.6% increase in sales; however, operating costs also rose by more than 7%.

While AKS and X stock are well positioned for growth, I have concerns over their valuations. X stock has been very volatile over the past year, gaining 45% since June 1. Despite X’s nominal dividend yield of 0.8%, it has a price-to-earnings-growth (PEG) ratio of 4.6, suggesting it is overvalued.

AKS, which was down as much as 4% on Thursday, does not pay a dividend, and is up 52% since June 1 — suggesting that the sector upside has been priced in. AKS is buying Severstal Dearborn LLC from the Russian steelmaker OAO Severstal and is operating at a loss now, so it will take time to start ramping up profits.

The One Steel Stock to Buy Now

But perhaps the best of the steel stocks right now is Steel Dynamics (STLD). Last week, STLD’s earnings of 31 cents per share beat the Street by a penny; the U.S. steelmaker’s sales for the quarter totaled nearly $2.1 billion — nearly 15% higher than the same quarter last year.

The market liked the results: STLD shares jumped 4.5% on the news. STLD also acquired Severstal Columbus LLC from OAO Severstal for $1.62 billion — a deal that will boost its steel production capacity by 40%.

Steel Dynamics’ operating income came in 90% higher than a year ago, building upon stronger performance across all its segments. Other strengths are evident in STLD’s $357.5 million in cash and equivalents — up 47% from a year ago. STLD’s long-term debt of $1.74 billion is slightly lower than a year ago, reflecting the company’s efforts to improve shareholder value.

Steel Dynamics has some attractive valuation metrics: A PEG ratio of 0.75 and a forward P/E of less than 12 make STLD stock look like a relative bargain now. And the 2.5% current dividend yield is the highest in the steel sector. STLD stock has gained 25% since June 1, but I think it still has plenty of fire left for the future.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2014/07/steel-stocks-aks-x-stld/.

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