Three Steel Plays for the Recovery

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

Nothing moves the economy the way construction does. When construction starts gaining momentum GDP does as well. IMF expects the US economy to grow by 2.2% in 2013, but those estimations could be revised upwards if the Fed Reserve continues in its expansive mode and the US doesn’t fall off the fiscal cliff – which is the most probable scenario. Construction in the US means local steel demand. Even with two big steel consumers in economic trouble, the European Union (which is in recession and cutting steel supply rapidly) and China (which is decelerating its growth rate), there is huge upside from current prices for US producers. Below I looked for three bets on a change on the steel cycle. 

AK Steel (NYSE: AKS) is the most leveraged play in the US and is as risky as it gets. The company is a producer of flat-rolled carbon, stainless, electrical steel, and tubular products and operates 7 steel making plants in Indiana, Kentucky, Ohio, & Pennsylvania. The company just made three offerings (issuing debt and equity) and ended up with over $1.2 billion in liquid resources that should satisfy any requirements until, at least, 2015. Better prices and volumes (steel volumes are expected to be up by 1.8% in Q4 compared to Q3), plus the lower raw material costs (iron ore prices are flat on the floor right now), should benefit AKS going forward. Despite the lowered Q4 guidance that disappointed investors (the stock was down 35% during the last 5 trading days), I would expect a 2013 EBITDA of $400 million vs. the $182 million Credit Suisse expects for 2012. With a Market Capitalization of $395 million, AKS would be trading at a multiple of 4.5x EV to 2013 EBITDA and with a huge upside potential from M&A and debt reduction (net debt is over $1.2 billion) going forward. 

US Steel (NYSE: X) is the integrated steel producer of flat-rolled and tubular products and also where I disagree with most analysts. The company is going through a terrible environment for its products and is a leveraged risky play, but still pays a dividend (yield is 1%) and with a $2.9 billion valuation it is a great place to wait for M&A action when the cycle changes. The company has a debt overhang at over 4x 2012 EBITDA. Current valuation looks rich at first sight at 8x 2012 EV/EBITDA but following most analysts and putting 2013 EBITDA at over $1.2 billion then valuation goes to a much lower 5x EV/EBITDA multiple. A Price/Book at 75% makes X a leveraged play that is worth playing. 

Nucor (NYSE: NUE) is the safest and biggest (market capitalization of $12.5 billion) of all three bets. It’s a well-managed business that still pays a respectable 3% cash dividend yield. It has ample liquidity (more than $4 billion) and low debt at below 2x EBITDA which will allow the company to pick great assets at low valuations if the opportunity appears since it’s the only producer that has the balance sheet to do so. Valuation is not unreasonable given the terrible circumstances at 10x EV to 2012 EBITDA and 7x 2013 EBITDA.

All three stocks should pop if the cycle changes, since revenues will grow exponentially and all cost cutting made during the 2008/2012 period will be reflected in better margins for all steel producers. At current prices steel deserves a bet. Your risk aversion level will tell you which game to play if you have to choose between AKS, X or NUE. I believe the US is in recovery mode and the steel cycle is changing despite the strong headwinds that are coming from Europe and China. Historically, when real estate gains traction, steel does as well. I don’t think this time around it will be different.

martinzaldua has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Nucor. 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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