When Forbes Magazine highlighted U.S. Steel Corp. (NYSE:X) as being the 88th most shorted S&P 500 component, I made the decision to take a further look at the company. A month ago I wrote an article about U.S. Steel here at Seeking Alpha, entitled, "U.S. Steel's Corporate Culture and its Poor Financial Performance." So, the shorting that was highlighted by Forbes motivated me to take a new look at the company.
I also decided to compare the future of the steel industry in the U.S. with that of the industry in China, and then take a fresh look at U.S. Steel.
Economic Growth and Its Impact on the Steel Industry in the U.S. and China
Despite a certain euphoria regarding both the recent run-up of the U.S. stock market, as well as better unemployment numbers that were released last week, the overall performance of the U.S. economy is tepid.
For the fourth quarter of 2012, U.S. Gross Domestic Product (GDP) expanded a minimal .10 percent, over the previous quarter. The U.S. economy finished 2012 with growth of 2.2 percent. Forecasts for U.S. GDP growth for this year vary considerably. While there are projections of this year's growth at or in excess of 3 percent, I'm continuing to agree with a consensus of economists who indicate that the U.S. economy will grow approximately 2.4 percent this year.
I've been asked why I am generally bullish on the global steel industry. For me the reason is simple. Just as DNA is the basic building block of the human body, I see steel production as a basic building block of a country's economic growth, or for that matter, global economic growth.
While I'm optimistic as to the future of the steel industry in the United States, I am very enthusiastic as to the prospects for the steel industry in China. No, I didn't forget about Europe. I've given up any hope for Europe's economic future due to its many fiscal and political challenges. I'm therefore very negative on any steelmakers with significant European operations, including ArcelorMittal (NYSE:MT), which I've written about extensively here at Seeking Alpha.
I see the bright spot for the steel industry worldwide being China. I strongly believe that Chinese steelmakers should be on the radar screens of more investors.
China is the world's largest steel producing country. Its steel production should increase 4.6% this year to a record 7.5 million tonnes. Last year the steel industry was difficult worldwide. China wasn't spared, but even with 2012 being a challenging year for the steel industry in China, the demand for steel in China increased 3.1% over 2011.
The economic stimulus program announced by Beijing in September of 2012 has already proven to be bullish for China's steel industry. As I've written about here at Seeking Alpha, China's auto industry, which is a big user of steel has also been a beneficiary of the stimulus program.
I've reached the conclusion that a positive turning point for the steel industry in China likely occurred sometime in the fourth quarter of last year. Steel production in China is likely to continue to increase as governmental approval is obtained for major projects, including dams, hydroelectric facilities, nuclear facilities, ports, railroads and construction projects in rural areas.
But, there are numerous factors that affect China's steel industry. These include the continued consolidation of the industry, and despite the increase in steel demand in China last year, and a very likely increase in demand this year, I expect pressure on operating margins.
Revisiting U.S. Steel
When one takes a look at the full year results for U.S. Steel for 2012, it's not a pretty picture. The company's 2012 income from operations was $855 million. The company's loss for the year was $124 million, which included a loss of $353 million attributable primarily to the sale of its Serbian operations.
Because U.S. Steel's full year results for 2012 were impacted by the sale of its Serbian operations, a better indicator for the company's current operations would be to review the company's fourth-quarter 2012 results. But, for the fourth quarter of last year, U.S. Steel Corp. reported a loss of $50 million, or $.35 per share, compared to a net income of $44 million or $.28 per share for the third quarter of 2012.
On the positive side, U.S. Steel's fourth quarter 2012 results were significantly better than those for the fourth quarter of 2011. For the fourth quarter of 2012 the company's losses were $211 million or $1.46 per share.
U.S. Steel's share price has been a beneficiary of the recent run-up of the U.S. stock markets to record highs. I attribute this primarily to its inclusion in the S&P 500, and therefore benefiting by its shares' inclusion in index funds, rather than buying of the company's shares by investors because they're bullish on the company. With its 52 week range being a low of $17.67 and a high of $32.05, and with its shares closing today at $20.69, the company's shares are not trading anywhere near their 52 week high.
Because of its lack of profitability, U.S. Steel doesn't have a current PE, but its forward-looking PE for the year ending December 31, 2014 is 9.34. Perhaps too often I tend to focus on numbers, and as a result, instead of looking at forward-looking PEs, I'd much rather look at actual PEs.
I continue to be troubled, wondering how U.S. Steel can justify paying a dividend, when profitability is so elusive. I guess I'm a bit old fashioned, but I believe that dividends should be paid only when there are actual profits. On January 29th, U.S. Steel declared a dividend of $.05 per share. The company indicated that it had a strong liquidity position, which as of the end of 2012 consisted of $570 million in cash.
A Look at Global Steelmakers and Chinese Steelmakers
A starting point in comparing global steelmakers with Chinese steelmakers is to look at valuations and PEs.
The following are PEs of three global steelmakers:
- ArcelorMittal is not profitable, but its shares are trading at a forward PE for the year-ending December 31, 2014 of 10.23. The company's losses for 2012 were $3.74 billion.
- Nucor Corp. (NYSE:NUE) is profitable and its shares are trading at a PE of 29.96. The company's income for 2012 was $504.6 million.
- United States Steel (X) is not profitable, but its shares are trading at a forward PE, for the year ending December 31, 2014 of 9.34.
The following are PEs of three steelmakers with Chinese operations:
- China Industrial Steel (OTCPK:CDNN) is profitable and its shares are trading at a PE of 3.23. The company has not yet announced its 2012 financial results. I've written about the company here at Seeking Alpha, and believe that the company is well positioned to grow as China's economy continues to grow.
- Sutor Technology Group (NASDAQ:SUTR) is profitable, and its shares are trading at a PE of 7.26. For the second quarter of its fiscal year, ended December 31, 2012, the company had higher revenue, lower operating expenses, lower interest expenses and higher interest income, all of which contributed to a 71.4 percent increase in net income of $4.8 million, on revenues of $157.9 million.
- China Gerui Advanced Materials Group (NASDAQ:CHOP) is profitable and its shares are a trading at a PE of 3.17. The company has not yet announced its 2012 financial results.
From an investment perspective, I'm basically neutral regarding the steel industry in the United States. I definitely believe that Nucor is more attractive for investors than U.S. Steel, if for no other reason than Nucor's profitability. ArcelorMittal, which is the world's largest steel producer, and which has significant U.S. operations, is not only burdened by its loss of investment grade status, but its problems in Europe.
Based solely on profitability, continuing economic growth in China and China being the world's largest steel market, I find three Chinese steelmakers, China Industrial Steel, Sutor Technology Group and China Gerui Advanced Materials Group, all worthy of investor consideration. The PEs of all three companies are all substantially less than the PE of Nucor, which is almost 30.
Investing in smaller-capitalization companies, as well as investing in companies in emerging markets, including China, is not suitable for all investors, and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risk.
The companies discussed above include major global steel producers ArcelorMittal and U.S. Steel. Investors should be concerned about ArcelorMittal due to its problems in Europe and high debt levels.
Companies discussed also include smaller capitalization companies with Chinese operations. But the Chinese companies, whose shares trade in the U.S. are all U.S. reporting issuers and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.