Rebalancing Your Steel Portfolio

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

Not so long ago, on November 21, I recommended buying US Steel (NYSE: X), Nucor (NYSE: NUE) and AK Steel (NYSE: AKS). A week after that, I also recommended steel giant Arcelor Mittal (NYSE: MT). My main thesis was that they were undervalued and the market was going to revisit their valuations shortly. The market did exactly that. In one month prices soared in reflection to an everlasting loose monetary policy in the US and better economic prospects (Reuters just reported that US GDP expanded at a 3.1% annual rate, faster than previously estimated). So news appears good for the US steel sector, but prices are also reflecting a better environment. What should you do now if you did follow my advice? Let's take a quick look at valuations.

AKS is up by 21% since my recommendation. The company is an ultra-leveraged play in the US Steel sector. The company has a $1.25 billion net debt with a 2012 $182 million EBITDA. Even if EBITDA is expected to climb up to $395 million in 2013 you need to be aware of the risks. AKS is now trading at 2013 11.5x P/E and 5x EV/EBITDA. If you bought it, you profited--sell it. I am writing a post on AKS bonds in my Blog, Warrentrades, that you may want to look at.

X is up by 16%, and I think it has further room to go. With net debt at $3.5 billion and a 2012 EBITDA at $805 million, expected to grow up to $1.2 billion by 2013, it’s still a leveraged play. That said, fundamentals are much stronger than AKS's and the stock has increased as much as AKS. I would cut my position by 50% even if it’s trading at 2013 16.5x P/E and 5.5x EV/EBITDA. The reason is that I like it as a long term play on the US recovery and a possible M&A target.

In the same period MT is up by 20%. It is the steel king and I am sure it will perform well in the future, but it has huge operations in Europe where I do not see a recovery coming soon. If I had bought a month ago, I would be selling the stock at current prices. The company trades at 2013 23x P/E and 6.4x EV/EBITDA. I think there are better options within the sector.

NUE has always been my favorite steel company. Nucor means great management and amazingly strong balance sheet. That said, NUE has gone up by “only” 8.4% last month. This is the only steel company where I would decide to increase my current position. The company trades at 2013 14.2x P/E and 7.4x EV/EBITDA, but with much lower leverage. Just so you can compare with the other steel players listed above, NUE is expected to have less than 1x net debt over EBITDA next year. This means that NUE will be the only steel company in the US able to buy distressed opportunities if they were to appear in the horizon. This is my favorite long term pitch within the steel sector and I think it should outperform its peers going forward.

Housing is in recovery mode and unemployment is poised to decline. This should continue to help any steel related portfolio. That said, the rally has been very strong and maybe you should trade towards lower beta assets within the same sector. While very leveraged plays such as AKS and Mittal are up by roughly 20% since my recommendation, more conservative but better quality companies like NUE are up by less than 10%. Right now I would recommend going for quality over leverage. This means, go long NUE and sell the rest.


martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of ArcelorMittal. 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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