2 Stocks to Buy, 1 to Avoid

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

Chinese mills have controlled the production of iron ore, and thanks to the sustained demand for steel in China, iron ore prices recently touched their 4 month highs. Also India’s iron ore exports declined for the third straight year; 117 million tonnes in 2010, to 61 million tonnes in 2011 and 34 million tonnes in 2012. In a recent report, Saudi Arabia is reportedly having a boom in infrastructure spending, on the back of state backed and private investment and a research RNCOS expects the steel demand to increase by 20% annually, at least until 2015. The recovering housing sector in the US, Bank of Japan’s latest stimulus package and China’s $156 billion infrastructure spending plan, are further expected to create an upward pull on iron ore prices. In my opinion, this would be a great time to pick up some beaten down steel manufacturers.

However things are not going great in Europe as analysts expect the annual EU steel demand to slide by 8%. ArcelorMittal (NYSE: MT) which is the world’s largest steel producer has a huge exposure to Europe. The company reported a net loss of $709 million compared to a profit of $659 million in the last year’s quarter. The company also cut down its dividends to save $850 million annually in order to continue its business operations and repay its debt. Recently Moody’s downgraded ArcelorMittal’s debt to junk status with a negative outlook. ArcelorMittal’s net debt increased to $23.2 billion, rising $1.2 billion in the previous quarter. With cash and cash equivalents of just $3 billion, a huge debt pile up and negative free cash flow of $1.6 billion in the last quarter, I think, investors should stay away from this stock no matter how optimistic any article may be.

US Steel (NYSE: X), which is the largest steel producer in the US by volume, reported earnings of $44 million compared to $22 million in the last year’s quarter. The massive 100% increase in earnings was due to tax benefits of $27 million against a charge of $33 million in the last year’s quarter. Though the revenues dropped by 8%, the results beat the market expectations as the company’s European operations performed better than estimated, reporting $27 million in income against a $50 million loss in the last year’s quarter. The company was also able to reduce its quarterly capital expenditures from $225 million to $129 million YoY. US Steel’s total debt stood at $3.9 billion and the company generated free cash flows of $500 million. Also the company ended the quarter with $2.4 billion of total liquidity. With Debt/FCF of 7.8 and huge cash reserves compared to its debt, US Steel won't be having any problems with its lenders.

Nucor (NYSE: NUE), which is the largest steel maker by market value, reported net income of $110.3 million beating the street’s estimates despite a 6% slump in sales. Net operating cash flow stood at $678.2 million rising 78.27% compared to last year’s quarter. The company ended the quarter with $2.54 billion in cash and long term debt of $4.3 billion. In my opinion Nucor is well placed, and can cover its debt using its huge pile of cash and cash flows compared to its debt.

The Wrap Up

The steel market is rebounding, and investing in companies which have solid balance sheets is a logical investment strategy. On average, the industry is producing iron ore at 75% of its capacity, and I don’t think further expansions are required as companies still have room to ramp up their production levels. Economic conditions are challenging and only those companies which have solid financials will survive.

 
 


PiyushArora 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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