Any time a company is downgraded, the shares of the stock in focus tend to take quite a tumble. In this article, I wanted to focus on one company which was downgraded on Monday. According to Goldman Sachs, this steel company has a potential downside of 28% as, if industry-based conditions worsen, a sharp selloff could occur.
Schnitzer Steel (SCHN) - Most investors would think that a beat on both the top and bottom line estimates for the company would be a good thing. Apparently, Goldman Sachs disagrees and, as a result, has placed a Sell rating on the stock. According to an article featured on Bezinga.com, Goldman Sachs noted:
"We downgrade SCHN to Sell from Neutral with 28% potential downside to our new P/E and EV/EBITDA based $21 price target (vs. 2% upside for the coverage group). We cut our FY2013 estimate by 25% (to $1.50 from $2.00) on lower margin and volume assumptions. We believe issues of shredder overcapacity, which has depressed margins for the industry, are now also impacting SCHN at its lucrative West Coast market. We see competition getting fiercer in the East Coast, too. 2013 consensus estimates for SCHN are too high, in our view, implying doubling of earnings while global steel fundamentals indicate only modest growth in steel production next year."
Defending Against Recent Declines
As many investors already know, the steel industry (SLX) has had a pretty dismal 2012. Year-to-date, such companies as US Steel (X), and AK Steel (AKS) have seen negative returns of -24.94% and -39.44%. It should be noted that Schnitzer's returns have been just as bleak, as the company has demonstrated a year-to-date return of -34.77%. Are these companies taking a proactive stance in an effort to reduce declines and reinstate shareholder confidence? I think they are, and the steps these firms are taking could end up being vital catalysts for long-term investors. In an effort to minimize losses to shareholders and enhance revenue, AK Steel began raising the prices of many of its steel-rolled products back in August by $30/ton. Within the last week, US Steel has followed suit and began raising prices of its own by $40/short ton. In an effort to offset the declining price in ferrous-metal scrap prices, SCHN announced a 7% reduction in its workforce earlier this year.
A Short-Long Strategy
In terms of the Goldman downgrade, I personally think there are way too many assumptions. By cutting EPS estimates for FY2013 by 25% and citing tougher market conditions on both US coasts, I think any selloff in the stock would actually create a buying opportunity. How should potential shareholders play the Goldman downgrade? A small to medium sized short position should be established over the next few sessions and, as a long as the company's share price continues to decline, the position should be held. Once an influx of buying ensues, that short position should be covered and a long position should be established, especially since analyst firm DA Davidson has a $36/share price target on SCHN.