Sell U.S. Steel Despite Improved Earnings

Oct.30.12 | About: United States (X)

U.S. Steel Corp. (NYSE:X), the largest producer of steel (in terms of volume) in the US, released its third quarter earnings today, which were better than the last year's results as the profit went up from 15 cents per share to 28 cents per share. However, the company is not expecting good results in each of its three revenue-generating segments - flat-rolled, European and tubular - in the fourth quarter which paves way for my recommendation of taking a short position in the stock in the near-term.

The main point of concern is the year-over-year fall in the operating income from $199 million in 3Q2011 to $62 million in 3Q2012. On a similar note, Chief Executive John Surma was heard saying, "Our results are expected to reflect continued weakness in the European and Emerging Market Economies, as well as economic uncertainty in North America. We expect total reportable segment and Other Businesses operating results to be around break-even for the fourth quarter with decreased results in all reportable segments."

The major reasons for an expected poor performance in the upcoming quarter are the lower average realized prices, higher operating costs and lower shipments. Steel's demand remains weak primarily due to the euro-zone debt crisis and lethargic economic growth in China, the biggest consumer of the commodity in the world. Also, steel companies, despite waning prices and weak demand, have kept high production levels (excluding few exceptions) which have added to the list of problems that the industry is currently facing.

On a positive note, the company holds a strong liquidity position, as it has $536 million of cash and its total liquidity amounts to $ 2.4 billion. However, the high beta and high fixed-cost structure makes it largely dependent on the macroeconomic environment, in general, and the dynamics of the steel industry, in particular.

In the long-term, the company has some positives which might entice investors to invest in the company in order to benefit from a potential turnaround in the steel industry. The stock trades at a forward price-to-earnings ratio of almost 10x. Its EPS is forecasted to improve by 57% next year. It also pays a dividend yield of 1%. It trades at 86% of its book value, and its beta of more than 2.3x makes it highly valuable for an investor who is aiming for a huge upside in the long-term.

The following table compares U.S. Steel with its competitors, Steel Dynamics (NASDAQ:STLD), ArcelorMittal (NYSE:MT), Nucor (NYSE:NUE) and AK Steel (NYSE:AKS). I have already covered STLD and NUE in my earlier articles. The main problem with the industry is that it is facing the problem of "prisoner's dilemma". A reduction in production capacity would benefit all the market players, but no single player is willing to cooperate and take the first step - and therefore all are losing on their ends.

X

STLD

MT

NUE

AKS

Price/Book

0.86

1.19

0.44

1.67

-

Forward P/E

9.88

9.76

7.92

13.45

12.07

Current Price

$21.15

$12.78

$15.44

$40.22

$5.19

52-week range

17.63-32.34

9.94-16.26

13.12-22.84

33.56-44.48

4.44-10.19

Dividend Yield

0.95%

3.13%

4.86%

3.63%

-

YTD Share Price

-20.07%

-2.81%

-15.11%

1.63%

-37.17%

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