2 Steel Producers To Stay Away From, 1 To Buy
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When it comes to uncertainty, steel is one of the riskiest industries out there. Once the largest public company in corporate America (the first $1B company), US Steel (NYSE: X) is in the red and, all in all, beaten down. AK Steel Holding (NYSE: AKS) has been on a consistent slide down with the stock worth less than two-thirds of where it stood just 12 months ago. Even ArcelorMittal (NYSE: MT), which is led by top management and has excellent emerging market opportunities, has lost more than a quarter of its value since 12 months ago. In my view, Arcelor Mittal is worthy of a "strong buy". Below, I review the fundamentals of ArcelorMittal and its competitors.
US Steel and AK Steel Holding
America's iconic steel producer trades at 7.1x forward earnings but is still rated closer to a "sell" than a "buy" on the Street. AK Steel is heading towards a sharper recovery but trades higher at 8.3x forward earnings and is also rated even closer to the "sell" side than US Steel is. Analysts forecast 22.3% annual EPS growth for AK Steel over the next 5 years versus just 5% for US Steel.
Since both firms are ultimately turnaround plays, it is very important to look at the fundamentals. One huge problem with both is that manufacturing is, well, cheaper and more convenient abroad. The union contract with the United Steelworkers (USW) expired at midnight on Sunday for US Steel. Supposedly, the USW has reached a new three-year agreement with the American producer while talks with ArcelorMittal have stalled. In my view, this is actually a bad thing - it is indicative of poor relative bargaining power for US Steel. As one analyst noted in the second quarter earnings call for US Steel: "one of your competitors in North America is going for some pretty steep reductions in wages… And my sense was that… maybe you guys weren't asking for big cuts anywhere".
During the 2Q, AK Steel suffered from a domestic decline in selling prices due to surpluses. The company has been raising the companies more than once in August, which indicates that it is gearing up for weak demand. It is also suspending its dividend mostly due to the lack of visibility. I recommend staying away from both US Steel and AK Steel for producers with more proven fundamentals.
ArcelorMittal fits the bill. It trades at 6.8x past earnings, less than two-thirds from its 52-week high, and near the 52-week low. Volatility may be high at a beta of 2.2, but the company offers an impressive 5.1% dividend yield to hedge against the risk. Moreover, analysts rate the company closer to a "buy" than a "sell" and have a $23.77 price target on the firm.
Let's look at the fundamentals to judge where they may go in the future. Capital expenditures were very high in 2011 while cash flow was unusually low. However, ArcelorMittal yielded free cash flow of $11.6B over the last four years, or $2.9B, on average. The stock is currently worth $22.8B, which means that the firm has a very impressive free cash flow yield of 12.7% - to say nothing about growth. Profit margins and revenue may be uncertain, but, should the company, do around average - it is worth much more than what the market is currently assessing.
I am also impressed with the company's labor position, as mentioned above. ArcelorMittal once tried to get labor to concede that workers were not entitled to pension benefits. It has since backed off from such a demand, but the idea that it could even propose one to begin with is foreign to AK Steel and US Steel. ArcelorMittal is well capitalized to grow with a current ratio of 1.4x and a debt-to-equity ratio of 0.5x. I recommend buying shares to capitalize off of multiples expansion and strengthened macro trends.
TakeoverAnalyst has no positions in the stocks mentioned above. 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.If you have questions about this post or the Fool’s blog network, click here for information.