US Steel (X) and AK Steel Holding Corp (AKS) have both had an interesting week, as they both released their earnings for the 4th quarter on Tuesday (January 28th), which tops off an interesting year for the steel industry. US Steel reported earnings that missed expectations with respect to revenue, but beat expectations with respect to profits after adjustments for special items. Earnings Per Share after adjustments for one-time events was up 2 cents higher then originally expected by analysts. Also on Tuesday, AKS reported earnings that beat expectations for EPS by 4 cents. Naturally both companies saw increases in their share prices throughout the duration of the week as a result of overall positive news reported in the earnings reports.
However only a day before, on Monday (January 27th), shares for both companies were falling. US Steel had released their guidance which was largely criticized by analysts with CitiBank analysts indicating that they considered it to be severely off the mark with respect to the changes happening to the demand for steel worldwide. JP Morgan analysts indicated that they were chiefly concerned with the price per ton which steel might continue to obtain. Clearly if the price of steel goes down, this will negatively impact the steel industry. There are some analysts whom seem to think it will fall throughout 2014. We had the following statement from JP Morgan with respect to steel and namely, US Steel and AK Steel Holdings:
We expected the combination of domestic capacity returning to the market at the time of weakening cost support from iron ore and coking coal would depress U.S. prices.
The first part concerning domestic capacity clearly might be a negative driver for the price of steel, however it is non-sensical to implicate that lowering input costs (Iron Ore and Coking Coal) might somehow not help the profitability of steel. Shouldn't cost reductions in inputs increase profitability even if demand for steel were to fall? Shouldn't this be more of a concern for the mining industry such as Cliffs Natural Resources (CLF) or Vale (VALE), and not steel companies?
However for the average steel investor, confusing analysis from major firms is nothing new. For the greater part of 2013 and throughout the first month of 2014 we have seen how the analysts consistently seem to fail with respect to their price targets for both AK Steel Holding and US Steel.
In the effort of full disclosure, I don't own US Steel or AKS, and I'm not about to present either a bullish or bearish perspective on the industry. I am not about to buy either US Steel or AKS and I do in fact, for reasons not stated by JP Morgan in their analysis of the steel industry, believe that Nucor (NUE) is a better alternative for a long term investment horizon (If you click the link above you will see that JP Morgan believes NUE might be a solid bet within the steel industry as well). So I suppose that in a sense the analysts and I agree, but for completely different reasons and certainly not on a consistent basis. For the most part I find fault with most analysts because of their tenuous causal relationships between X and Y industry. Overall, I believe that AKS and US Steel both serve to highlight the trouble with analysts' projected price targets.
In a recent article from Value Walk we have the following graph with respect to target price recommendations from major investment groups:
There are of course conflicting studies that indicate that major investment analyst firms have higher accuracy then simply 50% of the time. However these studies generally do not show the accuracy as being so much higher as to warrant our undivided loyalty to one set of analysts versus another. Since the average Seeking Alpha user can not possibly hope to gain from the composite total of advice from investment firms it might be best to simply disregard it except for the opportunities that are created through the fall in prices resulting from the asymmetry of the information available to the widespread market.
Trusting analysts is about as good as trusting a coin flip when it comes to AKS and US Steel. Here is a brief summary of how two major analysts got it wrong in 2013.
Nomura and AKS:
On July 3rd 2013, Nomura lowered their target price on AKS from $6 per share, which was higher then the market at that time, down to $3 per share which is what the stock was trading for anyway. This reflected a standard neutral rating for the stock and Nomura urged people not to buy the stock. This is how the stock reacted for the subsequent 6 month period:
Then on January 16th 2014, Nomura again rated AKS as neutral, raising the price target from $3 per share to $6 per share and urged investors to look elsewhere for genuine bargains. We have yet to see how this story turns out during 2014 for AKS, however at Friday's closing price of $7.07 we can only imagine that Nomura was once again wrong with respect to their analysis.
Nomura and US Steel:
Nomura had the same scenario of events happen with respect to US Steel. On July 3rd of 2013 they indicated that the price target for US Steel ought to be $18 instead of their original $20. Since this was the price of US Steel at the time they rated the stock as neutral, indicating that it would not outperform the market.
Here is how US Steel's stock price reacted over the next 6 months:
In the same way that they increased the price target for AKS, Nomura raised the price target for US Steel to what it was almost trading for, $27 per share.
Nomura and the Steel Industry in General:
Here is a statement from their analysis on January 16th:
We believe investors will get an opportunity to buy the stocks at lower price levels once the sheet market corrects back towards fair value levels.
If the sheet market corrects back towards fair values, then wouldn't we really be simply buying the stock for exactly what it is worth at that point in time in the future? Yes it would be cheaper, but it should be IF the market corrects within the context that Nomura indicates.
Another point taken from this group:
Following the strong run in the sector (we believe driven primarily by fast money) we expect to see equity price weakness into 2Q as sheet and scrap/iron ore values correct, which we would then view as a better entry point for the integrated names.
And here is the classic "input pricing" argument with respect to stock analysis. How do they expect Iron Ore and Scrap to correct? If Iron Ore were to go up based on the increase in demand for steel then this analysis would be fine. However this is actually the reverse of what is in fact happening. Iron Ore has been dropping due to a decreased demand for steel made in China, a major consumer of Iron Ore. Once again we must ask ourselves, why is this the conclusion being reached from this type of causal relationship? Shouldn't the analysts have the contrary perspective?
Wells Fargo and the Steel Industry:
AK Steel Holding Corp:
On July 1st 2013 Wells Fargo indicated that they thought that AKS would not do well and revised their price target of around $3 - $4 down from their previous price target of $4 - $5. Once again, $3 was roughly the price that AKS was trading at anyway. We also know from our chart above that AKS managed to beat the expectation of Wells Fargo quite well.
During the same announcement indicating that the price target for AKS was now down, they indicated the following with respect to US Steel:
US Steel also has less room for upside potential in our view as it does not benefit from raw material cost reductions in the U.S. due to its own internal iron ore mining
Once again, US Steel proceeded to defy the analysts at Wells Fargo and gain roughly 65% in stock price during the next six months (see chart above).
Wells Fargo's analysts proceeded to indicate time after time during the ensuing six month period that the steel industry was a bad investment. They continued this trend of analysis in during the recent month of January, perhaps now they will be right.
Ultimately, this is not an article which is presenting a case for or against the steel industry or US Steel and AKS. But AKS and US Steel do highlight the issues with analysis from major firms. Generally after negative analysis is released, a dip in the stock occurs. Perhaps on many occasions the analysts get it right. However often it would also appear that they do not. One thing is certain, if we wait until Nomura or Wells Fargo analysts think the steel industry is worth our investment, we will have lost out on a tremendous amount of profit potential.