This Steel Stock Is Rallying, And It May Continue

Aug. 4.14 | About: United States (X)

Summary

U.S. Steel is posting impressive numbers.

The company is turning around as the global economy recovers.

Future gains may be in store thanks to cost controls and increasing production.

Steel stocks have had an extremely difficult time for many years. Since steel is a highly cyclical industry, companies that produce steel saw great volatility in their profitability, alongside the swings of the global economy. For several years, United States Steel Corp. (NYSE:X) racked up huge operating losses, since demand fell off a cliff due to the recession.

Fast forward to today, and a vastly different picture emerges. Judging by its share price performance over the past 52 weeks, you'd think U.S. Steel was back in its heyday. Shares of U.S. Steel have nearly doubled over the past year, including a huge 20% rally on July 30.

Here's why U.S. Steel is beating the broader market so handily over the past year, and what it means for the company's future.

A great earnings report fuels takeoff
The reason for U.S. Steel's dramatic rise on July 30 had to do with its quarterly earnings report, which showed outstanding results. U.S. Steel's net loss shrank considerably from the same quarter's results the year before. In all, U.S. Steel posted a net loss of $18 million, down from $78 million in the second quarter of 2013.

The company improved its balance sheet as well. U.S. Steel ended the quarter with $1.5 billion in cash, up from just $600 million at the beginning of the year.

Others in the industry are reporting similar success. For example, Nucor Corporation (NYSE:NUE), which is North America's largest recycler, posted 13% revenue growth and 70% earnings per share growth last quarter, thanks to rising shipments and lower costs. As a result, U.S. Steel's impressive results aren't an outlier. Clearly, there's a steel recovery afoot.

And yet, on the surface, U.S. Steel's results don't seem worthy of a 20% spike. After all, it hardly seems like a company that lost money would be deserving of such an incredible rally. However, digging deeper reveals the reason for its incredible run.

What's driving investor optimism
Investors are clearly expecting U.S. Steel's results to improve substantially going forward, which is likely because the factors that dragged it down last quarter should be temporary. For example, U.S. Steel put up fairly poor results in its core flat-rolled segment. But that was due primarily to harsh winter weather that limited production and resulted in significantly higher operating costs.

Looking ahead, management expects operating profits to increase substantially in the current quarter, particularly in the flat-rolled business as weather and operating conditions have improved. This should help keep production strong.

Plus, investors were treated to a better-than-expected economic report to hang their hats on. Gross domestic product in the U.S. expanded by a 4% annualized rate last quarter, far better than expectations and proof that the decline in domestic GDP in the first quarter was due to harsh weather, and not a true decline in economic activity.

As mentioned earlier, steel is closely tied to broader economic growth. Investors are now buying the thesis that the steel industry, like the overall economy, struggled mightily in the first part of the year because of weather, and is now looking forward to better results ahead.

The key takeaway
U.S. Steel is putting up results that don't look overly impressive on the surface. And yet, its stock price has rallied tremendously over the past year. You might be wondering how this could be possible, since U.S. Steel still lost money last quarter.

The answer is that the stock market is a forward-looking mechanism. Investors are willing to overlook U.S. Steel's loss this quarter, because it represented much better performance than analysts expected. In addition, the company expects continued momentum in the current quarter. This upholds the notion that economic growth was restrained through the first part of the year due to weather, and not something more serious.

U.S. Steel deserves a lot of credit for getting itself on much firmer footing than it was just one year ago.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.