Surprise: A Value Play in Steel

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

The Dow Jones US Steel Index has risen by nearly 10% over the last 6 months, and Credit Suisse expects the index to further rally. The avoidance of the fiscal cliff and the recovering US, Chinese, and Indian economies, are expected to be a positive catalyst for steel prices. This presents a bullish case for steel manufacturers, but not all of them have bullish prospects to rally.

Because of high steel prices, Credit Suisse upgraded US Steel on January 2. US Steel (NYSE: X) may be able to deliver stronger cash flows, but its underlying problems are far from over. The company has a high debt/equity ratio of 103% with a negative profit margin of 1.45%. Moreover its PEG of 4.53x is way above the industry average of 0.8x, and quarterly revenue growth also lagged the industry average of 5%.

The thing is, a good business may not perform well in a poor industry, but a poor business can perform decently in a recovering or booming industry. US Steel may be able to report positive earnings, but I believe that investing in a company with good fundamentals would lock in greater returns.

It’s the same story for ArcelorMittal (NYSE: MT). With sales in excess of $85 billion, the company had a negative profit margin of 0.9%. Its TTM gross margin of 9% was below the industry average of 16%, while its quarterly revenues shrank by 19%. Moreover, its revenues over the last 5 years have shrunk by 33.8%.

But it carries a yield of 4.26%.

Oh Wait!

The management recently announced that it would be cutting its dividend from $0.75 to $0.20. This means that its yield of 4.26% would crash down to a meager 1.62%. The company has a huge presence in Europe, and it’s the poor macroeconomic conditions in the region that has been dragging down ArcelorMittal’s financials.

So Where To Invest?

Over the last year, shares of ArcelorMittal have declined by 9.72% and US Steel lost 10.62% of its market cap, but shares of Gerdau managed to gain 12.59% over the same time frame.

Gerdau (NYSE: GGB), a Brazil based company, recently reported quarterly sales growth of 10% on a YoY basis, and its gross margins stood at 12.95%. The company has a debt/equity ratio of 55%, which is lower than most of its peers. Additionally, the current ratio of 2.17 is modest, but again, it’s higher than most of its peers. Its shares appear to be undervalued as they carry a forward P/E of 8.51x with a PEG of 0.88x. Additionally analysts expect its annual EPS growth to average around 12% for the next 5 years that means its shares could double in value in less than 6 years.

Earlier this year, the company had announced its plans to invest BRL 838 million, which would nearly double its iron ore production by the end of 2014. The management recently announced that its new investments worth BRL 500 million would increase its installed mining capacity by 11.5 million tonnes to 18 million tonnes by 2016. By 2020, the management aims to achieve 24 million tonnes of annual production capacity.

 
 


PiyushArora has no position in any stocks mentioned. 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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