In the last month, United States Steel (NYSE:X) stock has surged 30% already-from oversold levels. Still, the stock still remains underwater, down 27% year to date. That 2019 performance pales in comparison to the 4.7% year-to-date gain in the VanEck Vectors Steel ETF (NYSEArca:SLX), which holds 27 steel and related peers of U.S. Steel stock.
U.S. Steel, being an integrated steel producer, is sensitive to fluctuations in the macroeconomic scenario. This is the first reason to remain underweight on the stock. Business fixed investments in the United States declined by 0.4% in the third quarter of 2019. This is in comparison to an average of 0.3% increase in business fixed investment in the prior four quarters.
With the private sector being the dynamic sector of the economy, it is clear that the slowdown has accelerated. Not surprising that the Federal Reserve has already cut interest rates three times in 2019.
It is also worth noting that the global manufacturing purchasing manager index for September 2019 was 49.7. We are already in a manufacturing sector recession globally. The global services sector PMI was 51.6, but has been on a gradual decline. These are ominous signs for the global economy.
There are hopes that the trade war will continue to de-escalate as economic losses mount for both the United States and China. United Nations economists already warned that the trade war is a “lose-lose” situation for the world. De-escalation can provide some growth catalyst, but it’s too early to expect renewed strength in the global economy. This is likely to have a negative impact on X stock.
Worsening Credit Metrics for U.S. Steel
With clear signs of sustained economic weakness, I am concerned about the worsening of credit metrics. For Q3 2019, the company reported an adjusted EBITDA of $144 million as compared to an adjusted EBITDA of $526 million for the same period last year. During this comparable period, the EBITDA margin compressed by 900 basis points to 5%.
The direct impact is on the company’s cash flow and leverage. For financial year 2018, U.S. Steel reported operating cash flow of $938 million. Considering year-to-date 2019 numbers, the annualized cash flow is likely at $528 million.
At the same time, the company’s net debt increased to $2.1 billion in Q3 from $1.4 billion at the end of 2018. Further, U.S. Steel expects 2020 capital expenditures to be $950 million. With declining cash flows, it is entirely likely that debt will increase.
Therefore, leverage has increased and I expect that to continue. It will translate into higher balance sheet stress in the coming quarters.
I also want to point out that X stock is currently paying an annualized dividend of 20 cents. If the economic weakness persists in 2020, U.S. Steel is likely to suspend dividends. This can also result in stock re-rating on the downside.
Final Thoughts on X Stock
Another important reason to believe that X stock is likely to trend lower is the valuation. The stock is currently trading at a forward price earnings ratio of 60.54. If margin compression continues, the forward PE will remain expensive and makes the stock less attractive.
Of course, forward valuations can change significantly when the industry recovers. However, I don’t see that possibility in the coming quarters. The IMF opines that GDP growth in advanced economies will remain at 1.7% in 2020 after forecast growth of 1.7% in 2019. Therefore, 2020 can be equally challenging for U.S. Steel.
Amidst all near-term concerns that will dominate the stock trend, U.S. Steel stock is worth considering in the range of $9 to $10. From a technical perspective, the stock is likely to find support at these levels.
Further, there is little doubt on the point that U.S. Steel has competitive positioning in high-margin end markets. This will help the company recover swiftly once GDP growth gains traction.
I also believe that the company’s investment in Big River Steel is likely to yield positive results in the long-term. Big River is a technology-oriented steel company with focus on new product development that caters to future demands from various industries. Big River Steel also boasts of the first Leadership in Energy and Environmental Design-certified (LEED) steel production facility.
Overall, X stock is worth keeping on the investment radar, but the stock is not trending higher anytime soon. On the contrary, shares are likely to cool-off after a sharp near-term rally.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.