US Steel: Is It Worth Taking A Chance?

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

US Steel (NYSE: X) is the largest steel producer in the U.S., and the 13th largest in the world.  But its shareholders have had a rough time over the past several years, with the stock falling dramatically from its 2008 high of $196.00 to a post-crisis low of $16.66 in 2009.  Although US Steel enjoyed a nice rebound to the $60-$70 level in the 2010-11 period, itsshare price is fallen again, currently around $25.  US Steel is one of the rare companies still trading so close to the 2009 lows. 


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With concerns about unfunded pension and healthcare liabilities looming, as well as a very high ratio of long-term debt to assets, is US Steel worth taking a chance on?  With the company set to report earnings Jan. 29, maybe the company will offer some solutions to these concerns.

In the United States, US Steel’s main competition comes from AK Steel (NYSE: AKS), Arcelor Mittal Steel (NYSE: MT) and Nucor (NYSE: NUE).  Due to cost-cutting, the industry is very competitive, and profits can be low.  Because of its size, US Steel has a raw materials cost advantage over AK Steel and Nucor, and it can generally undercut Arcelor Mittal.  Since Arcelor is not based in the U.S., with transportation and raw material costs rising worldwide, it is getting more and more difficult to compete with U.S. companies domestically. 

Additionally, AK Steel, arguably the closest competitor to US Steel, business-model wise, has employed similar cost-reduction measures, but not to the same extent.  As a result, AK Steel is projected to have lost $0.61 per share for 2012, with projected earnings of $0.11 for 2013. 

The same can be said for Arcelor Mittal, which is projected to have barely earned a profit in 2012, with estimates calling for $0.04 per share.  

Nucor simply seems overvalued, trading at 17 times the forward earning consensus of $2.81.  US Steel, on the other hand, trades at 16 times forward earnings, with a higher projected earnings growth rate than Nucor.  On a valuation and profitability basis, US Steel simply looks to be the cheapest in its industry.

I believe (as do most analysts) that US Steel’s earnings will recover nicely over the next few years for several reasons.  First, the company has taken measures to get its pension and healthcare costs under control, so earnings should rise as these costs decline over the next several years.  Pay attention to anything the company has to say in regards to this, as the underfunded obligations have been a major concern among investors for some time now.

Second, steel demand will increase as the economy recovers.  The two biggest end markets for steel are the auto industry and construction, including infrastructure projects.  More important than any earnings numbers themselves will be any indicators of rising or falling demand, such as how much steel was produced last year.  For comparison, in 2011, US Steel produced 18.6 million tons in North America and 5.6 million tons in Europe.

Finally, the trend in the steel industry has been toward consolidation.  Fewer producers leads to more efficiency as companies enjoy greater economies of scale, as well as more stable pricing.  Steel is a highly cyclical industry, and consolidation should lead to less profit swings during the business cycle. 

In terms of valuation, I think US Steel is very attractively priced.  Consensus estimates call for the company to report earnings of $0.87 for 2012 (up from $0.46 in 2011), which are expected to grow to $1.51 and $2.27 in 2013 and 2014, respectively.  This means that the expectation is for a average annual earnings growth rate of 71% over a three year period, more than justifying the 16.4 times forward earnings P/E ratio. 

Of course, 71% growth isn’t sustainable for a very long amount of time.  So, how far can this company’s earnings grow?  It all depends on the demand for steel, commodity prices, and the company’s profit margins.  There is a great deal of potential if the economic conditions go US Steel’s way, after all, this is a company that earned $17.96 per share in 2008. 

KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Nucor. 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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