U.S. Steel: Too Cheap To Ignore Again
Summary
- Steel stocks have generally had a difficult stretch ever since early 2018.
- That has started to change in recent weeks, as steel prices have surged higher, which will eventually translate into rising earnings estimates for the steel producers.
- U.S. Steel common shares are down materially from their 2018 highs.
- Rising steel prices will provide a catalyst, and this will be buoyed by the reflationary narrative that's just now getting started.
- Look for a rally similar to the one we got in 2016, as global growth fears fade, and a global growth reflationary narrative develops.
- This idea was discussed in more depth with members of my private investing community, The Contrarian. Get started today »
Try to buy assets at a discount rather than earnings. Earnings can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings. - Walter Schloss
Introduction
Taking a break from writing about natural gas equities, which I will return my focus too shortly, and taking a break from the U.S. election drama, I wanted to focus on U.S. Steel (NYSE:X), as rising global steel prices are providing both a catalyst and a tailwind that are not fully incorporated into U.S. Steel's current share price.
This hidden reflationary narrative, which seemed to be dying on the vine last week in the wake of an apparently gridlocked U.S. government, received a substantial boost on Monday, Nov. 9, 2020, as the Pfizer (PFE) BioNTech (BNTX) positive vaccine news jump started a historic capital rotation day in the markets.
This historic capital rotation is something I have alluded to, and written about frequently, and it now appears to be in sight, with a couple of more hurdles to pass until we get there, including a recent surge in COVID-19 cases. With each positive data point on the treatment front, with another upcoming vaccine update from Moderna (MRNA) on the horizon, investors should start looking forward to a historic capital rotation from the in-favor growth stocks to the out-of-favor value and cyclical stocks.
There are interesting bounce back recovery candidates in REITs, including Simon Property Group (SPG), which I wrote about here, in directly impacted sectors like travel, which I wrote about here with Boeing (BA), yet the heart of the upcoming value opportunity is going to be in the out-of-favor cyclical stocks, including energy equities, and basic material stocks.
Notably, there have been strong price recoveries in a number of these equities already in 2020. However, from a bigger picture perspective, these price moves are most likely just getting started. Personally, I think that's the case with U.S. Steel, a stock that really should never be an buy-and-hold equity, yet its shares are materially below its early 2018 highs, and that gap is the recovery potential in a best-case scenario.
U.S. Steel Performance Year-To-Date In 2020
It has been a roller coaster year for many equities, and commodity equities have had an amplified up and down ride, yet as a broader group they appear to be turning the corner.
However, U.S. Steel shares remain down year-to-date in 2020, even after a strong bounce from their March 2020 lows.
(Source: Author, StockCharts.com)
Compared to the S&P 500 Index, as measured by the SPDR S&P 500 ETF (SPY), and steel peers Nucor (NUE), Steel Dynamics (STLD), which I have worked with directly in a previous career financial analyst position, and Cleveland Cliffs (CLF), U.S. Steel shares have underperformed year-to-date in 2020.
(Source: Author, StockCharts.com)
Many analysts question U.S. Steel's positioning in a consolidated market, particularly with the acquisition moves Cleveland-Cliffsmade in 2020, acquiring AK Steel, and acquiring the U.S. operations of global steel giant ArcelorMittal (MT). Despite the skepticism, this consolidation is a positive, from my perspective, as U.S. supply/demand will be better balanced with fewer market participants.
Rising Steel Prices Are A Real-Time Catalyst
Right on cue, or perhaps a bit of luck with timing, steel price have indeed surged higher, following this consolidation activity, with a notable rise the past six weeks.
(Source: SteelBenchmarker)
Even though U.S. Steel's third quarter earnings came in better than expected, particularly on the EBITDA front (vs. previous guidance), and they raised EBITDA guidance for the fourth quarter of 2020, analysts are still behind the curve with their earnings estimates, given what has happened to steel prices over the past six weeks.
(Source: Yahoo Finance)
Looking at the earnings per share estimates above, look for these estimates to rise materially in the weeks ahead, as rising steel prices positively impact operating margins. Thus, the already expected improvement from 2020's results into 2021 will be even stronger than anticipated right now, as rising steel prices and rising margins get incorporated into the sell-side analyst forecasts.
Looking Back To 2016 and 2018 For Perspective
It seems like a decade ago, however, early in 2018, U.S. Steel was poised to earn $6 per share in 2018, and earnings had the potential to rise going forward with newly enacted steel tariffs.
(Source: Author, StockCharts.com)
Clearly, things did not work out as planned, with U.S. Steel shares falling from their highs around $45 all the way back below even their late 2015/early 2016 lows. If you recall, at that time, I wrote an article on U.S. Steel titled, "U.S. Steel: Too Cheap To Ignore," and U.S. Steel shares ending up being one of our biggest winners in The Contrarian, during 2016, surging from around $7 at their lows to near $40 per at their highs.
Could history repeat itself in 2020, with a phoenix rise from the ashes like 2016?
In my opinion, yes, as if you look closely at the chart of steel prices, shown earlier, and shown again below, they actually made materially higher lows in this bottoming process, than they did in late 2015/early 2016.
(Source: SteelBenchmarker)
Higher steel prices today, combined with a much better balance sheet than U.S. Steel had in late 2015 and early 2016 (the company has $1.7 billion in available liquidity today against a market capitalization of roughly $2.2 billion and an enterprise value of roughly $5.4 billion, yet they were near tapped out at the end of 2015) could lead to a similar, or better, share price outcome.
Closing Thoughts - A Historic Reflationary Narrative Is On Tap
U.S. Steel is never going to be a classic compounder, or a buy-and-hold equity, as the cyclicality of the steel business is too great for that, and their global competitive positioning is too weak. Having said that, shares of U.S. Steel can certainly offer upside to a historic capital rotation, something that I think is on tap, and something that we got a preview of on Monday, Nov. 9, 2020.
(Source: Bloomberg)
The two graphics above from Bloomberg show that global value stocks had their best day in over 20 years vs. global growth stocks on Monday, and momentum stocks, notably the FAANG quintet of Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOGL)(GOOG), stumbled badly on a relative basis.
This historic move came shortly after an almost equally historic move in the other direction on the day following the presidential election, which was Nov. 4, 2020, where investors rushed to FAANG, utilities, and perceived quality.
The whipsaw, back-and-forth nature of the markets on a day-to-day basis is confusing a lot of participants, however, the bigger picture is much clearer.
(Source: Longview Economics, Macrobond)
Specifically, commodities and commodity stocks are historically undervalued, both on an absolute basis and on a relative basis vs. the broader U.S. stock market. Individual and institutional investors alike, both struggle including non-correlated assets in their portfolios over the longer term, because these non-correlated assets often suffer streaks of incredibly poor relative performance. That has indeed been the case for commodities, and many commodity equities over the past decade, however, the great challenge of outperforming longer-term investors is to look forward, not backwards. If you think of that perspective today in the markets, the value opportunities should be clear.
In closing, U.S. Steel is hard to analyze on the surface. The company has negative EBITDA in 2020, it's trading at roughly 7.6 times its 2019 EBITDA today, and the future is beyond murky with an unknown global recovery path in front of us. Steel prices themselves provide some clarity, though, and steel prices today are materially above their 2019 levels right now, after falling earlier in 2020. If these steel prices hold up, U.S. Steel shares are going to start looking very cheap in the not too distant future, and investors want to be in front of this, looking forward, not behind it, looking backwards.
The Contrarian
There is historic opportunity in the investment markets today. I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past. From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009. For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.
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Historically, I have had huge wins and impressive losses based on a concentrated, contrarian strategy. Trying to keep the good while filtering out the bad.
Seeking to run an all weather portfolio with minimal volatility and index overlays to capture my strategic and tactical recommendations along with a concentrated best ideas portfolio, which is my bread and butter, but the volatility only makes it suitable for a small piece of an investor's overall portfolio. The following are a couple of my favorite investment quotes."Life and investing are long ballgames." Julian Robertson
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I’ve been on top of the world, and the world has been on top of me. I have learned to enjoy the perspective from each view, and use opportunities to persistently acquire knowledge, and enjoy the company of those around me, especially loved ones, family, and friends.
At heart, I am a market historian with an unrivaled passion for the capital markets. I have had a long history and specialization with concentrated positions and options trading. Made money in 2008 with a net long portfolio, deploying capital in some of the market's darkest hours into long positions including purchases of American Express, Atlas Energy, Crosstex, First Industrial Real Estate, General Growth Properties, Genworth, Macquarie Infrastructure, Ruth Chris Steakhouse, and Vornado near their lows. Shorting, hedging, and option strategies also helped me in 2007 and 2009, and these are skills that I have developed ever since I started trading heavily in 1996.I enjoy reading, accumulating knowledge, and putting this knowledge to work in the active capital markets, learning lessons along the way.To this day, I continue to learn, and some of these learning lessons have been excruciatingly difficult ones, especially over the past several years, as I made mistakes allocating capital, including a sizable portion of my own capital (I always invest alongside my clients), to commodity related stocks. While all commodity related stocks have struggled since April of 2011, coal companies, which attracted me due to their extremely cheap valuations, and out-of-favor status (I am a strong believer in behavioral finance alongside fundamentals and technicals) have been the worst investing mistake of my career. The focus on the commodity arena has been the biggest mistake of my investment career thus far, yet in its aftermath, I see tremendous opportunity, even larger in scope than the fortuitous 2008/2009 environment.The capital that I accumulated and the confidence gained in navigating the treacherous investment waters of 2008 gave me the confidence to launch my own investment firm in the spring of 2009, right before the ultimate lows in the stock market. At the time I was working as a senior analyst at one of the largest RIA's in the country, and I felt strongly that the market environment was the best time since 1974/1975 to start an investment firm.Prior to starting my firm, I was a senior analyst for three different firms over approximately 10 years (Charles Schwab, Redwood, Oxford), moving up in responsibility and scope at each stop along my journey. Since I was a paperboy, I have always had an interest in the investment markets. I love researching and finding opportunities. I was a Chartered Financial Analyst, CFA from 2006-2018. Additionally, I have been a Chartered Alternative Investment Analyst, CAIA. After starting in the teaching program at Ball State University, I switched to a career in finance when I turned a small student loan into a substantial amount of capital. I graduated summa cum laude with a degree in finance from Ball State.
Full disclosure, I am not currently a registered investment advisor, though I did serve in this capacity from 2009-2014, while owning Koldus Contrarian Investments, Ltd. Additionally, I held various securities licenses from 2000-2014 without a single formal complaint filed. At the end of 2014, I voluntarily let my state registration expire, as I transitioned the business to a different structure after going through a brutal business environment, divestiture and difficult divorce and custody battle. Prior to this, I had passed, and held, various securities exams and licenses, including the Series 7, Series 63, and Series 65 exams, in addition to others, alongside the CFA and CAIA designations. Unfortunately, I did not file the proper paperwork to withdraw my state registration, and I did not disclose a personal arrangement, and subsequent civil case, between myself and a former close personal friend and client. This arrangement was initiated informally in 2011, after a substantial period of success, as we aimed to be business partners, and it ultimately resulted in a dispute. I was unaware that I was required to disclose these items, and my securities attorney, at the time, did not advise me to do so. Previously, I had managed a portfolio for this gentleman, and we had taken an investment of approximately $7 million in 2009, and grown it to over $25 million at the beginning of 2012. After a very difficult year of performance, an employee of the firm I owned, and friend, resigned in early 2013, and took the aforementioned client to a competing firm. As a result of not filing the proper paperwork, I agreed to a settlement, with a potential $2500 fine in the future, depending on if I choose to reapply to be a non-exempt advisor. Additionally, while going through the difficult divorce and business dispute and divestiture, I did not file the proper disclosure on two of the annual CFA renewals. As a result, the CFA Institute sought a 3-Year Suspension of my right to use the CFA designation, which I appealed, since the primary investigator in the case sought a 1-year suspension of my right to use the CFA designation for a majority of the investigation. A Hearing Panel heard the case, and went against the recommendation of the CFA's Institute's Professional Conduct Department. Long story short, be careful who you trust, especially when substantial money is involved, and always disclose everything properly, which is hard to do when you are going through difficult situations, as this is the last thing you are probably thinking of at the time. In closing, I have had more experience in the markets, business, and life than most, yet I am grateful & thankful for every day. Additionally, I have learned through success and failures that you have to move forward, and if you can do this, your life will form a rich tapestry of stories.
Disclosure: I am/we are long X, BA, CLF, MT, SPG, AND SHORT AAPL, AND SPY IN A LONG/SHORT PORTFOLIO. 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.
Additional disclosure: Every investor's situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication and are subject to change without notice.