Dividend Buys in Out of Favor Steel

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

Recently, German steel giant ThyssenKrupp (NASDAQOTH: TYEKF) announced that it was eliminating its dividend for the year, the first such omission in more than a decade. For me, this highlighted the plight of the steel industry and made me wonder if there were any bargains floating around.

ThyssenKrupp's problems stemmed from a nearly $5 billion asset write down related to its Steel Americas unit, which it is dismantling. Essentially, as it disposes of these assets, it has determined that it won't be able to sell them for the value it has assigned them on its balance sheet. It highlights the fact that steel is an unloved industry right now. Note, however, that the rest of the company is surviving reasonably well. Clearly this is a tough transition for the company and its shareholders, but it is likely to result in a stronger company over the long term. More aggressive investors might want to keep this company on their watch lists.

Still, as the chart below shows, Steel has not performed particularly well. This isn't surprising after the housing bubble and China demand ran steel prices to impressive heights. Indeed, when the housing bubble burst and Chinese demand started to slow, steel stocks fell into a funk. The slow housing recovery and concerns about growth in China have kept demand for the commodity soft.

<img src="http://media.ycharts.com/charts/493fc5dee1ed75cd7a46b62a8e0e4449.png" />

SPY data by YCharts

A Dividend Champ
This doesn't mean, however, that there aren't some interesting options in the steel space. One company with an impressive history of dividend increases and innovation is Nucor (NYSE: NUE). The company is financially strong and has a modern and highly efficient fleet of steel mills. This gives it a material advantage over some of its peers. It also has operations in the scrap space, which helps to ensure a constant supply of steel for its mills. It makes a vast array of products, but its business is generally concentrated in the United States. Right now this is a negative, but could easily be a positive should the U.S. economy shift into a strong recovery mode. Note, too, that management is looking to more aggressively enter the export business, which should help in the near term.

Nucor has raised its dividend every year for well over a decade. The recent rate of increase hasn't been particularly impressive, but it shows the company's commitment to shareholders. The stock's recent yield of around 3.6% is interesting, but income oriented investors could probably get a better price. In fact, the stock was yielding closer to 4% earlier in the year. That might be the right target yield for this U.S. steel company.

Leverage!
U.S. Steel (NYSE: X) is in no way shape or form a good dividend play in the steel space. However, it is a highly leveraged bet on a steel turnaround that comes with a small dividend. Note that the dividend was cut when the going got rough. That said, the dividend was also increased materially when the company had the wind at its back, leading to a double benefit for shareholders of an increasing stock price and an increasing distribution. Part of the company's problems today stem from acquisitions made late in the up cycle that increased the company's capacity at precisely the wrong time. That said, the company has a great deal of control over its input costs and supply because, like Nucor, it has a material level of vertical integration. So while the shares have been hard hit by the steel downturn, there are some things to like.

In fact, the company's stock price is hovering around $20, well below the nearly $200 is saw just a few years ago. For investors who believe that steel is at a cyclical low, this could be a good leveraged bet on the eventual turnaround. Note that steel is a product that societies around the globe need to have for building everything from homes to cars to appliances. Although economic cycles are clearly important, it is unlikely that the industry is going anywhere. U.S. Steel has proven its ability to prosper in the good times and survive in the bad times, so while it is a risky play to some degree, the current price likely discounts most of the negatives out there today.

A Foreign Big Wig
ArcelorMittal (NYSE: MT) is the largest steel company in the world. The Mittal family made aggressive use of acquisitions to build this vertically integrated giant and now controls close to half the company's shares. The company has material operations around the world and appears well positioned to benefit from an uptick in the steel market. However, it has notable debt maturities over the near term that might cause some problems for shareholders.

So while the dividend yield of around 4% is clearly enticing, it is not without risk. Assuming the company is able to refinance its debt at acceptable rates and with limited concessions, the dividend is likely to hold. A large company, there is a good chance that this will be the outcome. However, if it can't get decent rates or has to agree to onerous debt covenants, that 4% dividend yield could quickly disappear. Note that the steel malaise has already resulted in dividend cuts, so further cuts are not out of the picture. This stock is probably best left to aggressive investors that expect a steel recovery. Of course, if that recovery does take place, the dividend and price are both likely to head higher.

Yours,

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ReubenGBrewer 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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