2 Reasons to Buy and 2 to Sell Steelmakers

Robbert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For some time the stock prices of large steelmakers have been going down. Major US and European steelmakers such as US Steel Corp (NYSE: X), AK Steel Holding Corp (NYSE: AKS) and ArcelorMittal (NYSE: MT) posted big losses in the most recent quarter. While steel is a commodity, European and US steelmakers have been hit harder by the recession than Chinese or Indian steelmakers. For both ArcelorMittal and US Steel, production volumes are down since 2008. But of course the big question is: is it a time to buy on this dip? I have found two reasons to sell and two to buy.

Risk
Investing in steelmakers is a risky business; US Steel and AK Steel haven’t made an annual profit for years, while Arcelor’s profits are in a rapid decline. The debt rating for Arcelor was recently downgraded to junk, so a debt holder may not assume he gets his money back. What does this mean for an equity holders? A shareholder needs an even higher return to compensate for the huge risk Arcelor  poses to his or her portfolio. US Steel also got the ‘junk’ credit rating (BB) from S&P, accompanied by a negative outlook, like MT. AK Steel recently experienced a severe downgrade by Moody's.

Worst to come
If you think this situation is bad, brace yourself, as it will get worse. According to analysts at Goldman Sachs, the worldwide demand for steel in 2013 will decline 4% from this year’s levels, partly due to slowing demand in China. If this happens, steel prices will plummet as overcapacity haunts the steelmakers. Also, analyst recommendations of all three stocks have deteriorated greatly since 3 months ago, indicating increasing pessimism about the companies’ ability to create value.

Much upside
With a tangible book value of $26.64 per share, ArcelorMittal looks valued at a fairly good price, although P/B isn’t that important. US Steel has a P/B ratio of 0.76, a fair discount with much upside. For US Steel, tangible assets are just over half of its market cap and AK Steel's tangible book value is negative, which makes Arcelor the safer company of the three in case of distress. The path of US Steel and Arcelor stock prices have been largely the same for over the last 5 years though.

<img src="http://media.ycharts.com/charts/ffdae70ae4227f2a3178d66083aea712.png" />

AKS data by YCharts

As you can see in the chart above, all three stocks have lots of potential when steel prices are high, like they were early 2008. This is the case because a steel mill isn’t built in a day and supply can’t keep up with demand, resulting in a much higher price.

Bottom of the cycle
Apart from the low price, the market for steel can’t deteriorate much more at this point. ArcelorMittal and European competitors are already shutting down steel furnaces or downsizing production. According to ArcelorMittal executives, demand will pick up in 2013. Combined with a healthier supply of steel, the pressure on prices will decline. The worldwide association for steel producers is also slightly optimistic, forecasting a 3.6% growth for North America and a 2.4% growth in the EU in 2013.

The Foolish bottom line
So should you buy or sell? I think a buying spree isn’t the way to go, but selling/shorting would be missing out on a recovery. Returning to 2010 levels won't be enough for US Steel and AK Steel. As steelmakers' stocks are highly cyclical, it is wise to keep their shares in your portfolio low when you are inclined to buy. When selling or shorting, prepare yourself for a painful moment if the economy unexpectedly recovers.


Investor89 owns shares of ArcelorMittal. The Motley Fool owns shares of ArcelorMittal. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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