U.S. Steel: Earnings Set To Surge

Summary

  • On Nov. 13, 2020, I published a bullish article on U.S. Steel, and since then, shares are higher by 109% vs. a 16% gain in the S&P 500 Index.
  • While shares have rebounded sharply, fundamentals have improved at even a faster pace.
  • The end result is that earnings and free cash flows, which have been consistently revised higher the past three months, will see further upward revisions.
  • Based on current steel prices, earnings per share could exceed $8 in 2021 and potentially exceed $10 per share.
  • With steel prices higher for longer now, these front loaded earning and free cash flows could be higher for longer than many analysts expect.
  • This idea was discussed in more depth with members of my private investing community, The Contrarian. Learn More »
Following Shot of Heavy Industry Engineers Walking Through Manufacturing Factory. In the Background Professionals Working on Construction of Oil, Gas and Fuel Pipeline Transportation Products
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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

"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria." - Sir John Templeton

"Life and investing are long ballgames." - Julian Robertson

Introduction

The past year in the financial markets have been more volatile than normal, and this has created significant opportunity, particularly in individual equities, as market participants try to divine the future projections of revenues, earnings, and free cash flows.

Building on this narrative, the inflection points, some of which have been building for roughly a decade, are happening at a faster pace than many investors have anticipated.

Nowhere is this more true than in the commodities market, where many commodities and commodity equities have been left behind the roaring bull market in traditional financial assets for much of the past decade, especially on a relative basis.

(Source: Author, StockCharts)

The chart above shows this dichotomy, with the CRB Index, which measures a basket of commodity prices, plotted against the SPDR S&P 500 ETF (SPY).

Notably, commodity prices appear to have made a multi-decade relative low, and we have seen strong advances in many commodity prices on an absolute basis, including copper, iron ore, lumber, oil, and steel prices.

Lumber prices and steel prices are actually making decade plus price highs (and all-time price highs), highlighting the supply/demand imbalance that has been created from a roughly a decade of underinvestment, and then the subsequent resumption of demand growth.

This turn higher in steel prices has benefited steel producers in aggregate, and the leading steel companies, including Nucor (NUE) and Steel Dynamics (STLD), which I have worked closely with in the past, are benefitting with their respective stock prices at or near all-time highs.

(Source: Author, StockCharts)

Both Nucor and Steel Dynamics are fine companies, however, the best total return potential at the current juncture, from my perspective, is in the most downtrodden steel companies with the highest operating leverage to increased steel prices. Cleveland-Cliffs (CLF), which I wrote about in this recent article, and U.S. Steel (NYSE:X), which I wrote about in the Nov. 13, 2020, article titled "U.S. Steel: Too Cheap To Ignore Again," fit the bill, and their share prices have started to respond accordingly.

In fact, U.S. Steel shares are up over 109% from when I published my aforementioned November 2020 article vs. a comparative gain in the S&P 500 Index (SP500) of 16%.

(Source: Author's November 13th, 2020 U.S. Steel Article)

The strong advance in U.S. Steel's share price is just the beginning, in my opinion, as revenues, earnings, and free cash flows are going to surge higher than analysts are estimating right now, even with analysts sharply revising their estimates higher over the past 90 days. The icing on the cake is that we are in the early innings of a potentially commodity super cycle, and this is far from priced into the financial markets, commodities, or commodity equities.

A Matter Of Long-Term Perspective

U.S. Steel shares have advanced sharply the past five months, rising like a phoenix in the post election melt-up in the broader equity markets.

(Source: Author, StockCharts)

However, from a long-term perspective, shares are nowhere near their all-time highs, let alone their 2018 highs.

(Author, StockCharts)

Many reading this many say there's a rationale for this price action as U.S. Steel's assets have been inferior, and they have diluted equity, which are both true, to an extent. The counterarguments would be that the higher cost legacy blast furnace operations have more leverage to higher steel prices, and part of the equity dilution was used to acquire perhaps the best modern steel asset in the United States in Big River Steel, which occurred at an opportune time and for a compelling price.

Steel Prices Have Surged Higher and For Longer Than Almost Anyone Estimated

Back when I wrote the Nov. 13 article on U.S. Steel, the steel pricing environment looked vastly different than it does today, even with steel prices turning higher at that point in time as the chart from the referenced article indicates below.

(Source: SteelBenchmarker)

Fast forward roughly five months, and steel prices have exploded upwards, far eclipsing their 2018 and 2008 highs.

(Source: SteelBenchmarker)

The magnitude of the rise in steel prices is hard to fathom, and it comes in a backdrop where most analysts, including those at Goldman Sachs (GS), expected steel prices to moderate, particularly in the second half of 2021 as recently as a month ago.

Instead of moderation, steel prices have continued rising, reflecting a structural supply/demand imbalance that is not being rectified by the steel companies collectively bringing their idled capacity online.

Just in the past three days alone, steel prices have increased materially in the fourth quarter of 2021, and into the first half of 2022, as this chart from the CME Group (CME) from yesterday afternoon illustrates.

(Source: CME Group)

With rising steel prices extending for longer than almost anybody anticipated just a few months ago, steel companies are scrambling to revise their earnings estimates higher and the sell-side is following suit.

Earnings Estimates Rising Materially, However, They Are Still Behind The Curve

All of the steel companies have raised guidance materially, punctuated by Cleveland-Cliffs taking their 2021 guidance from an EBITDA of $2 billion to an EBITDA of above $3.5 billion at the end of March of 2021, which is still going to prove conservative, as steel prices have risen further in the second half of 2021 since that guidance update. Keep in mind that the current enterprise value of Cleveland-Cliffs is $15.6 billion as I write this note, so their EV/EBITDA is roughly 4.5, which is very cheap.

Zacks Research put out a summary note, which highlighted the increased guidance from a number of steel companies as follows.

Upbeat Guidance from Big Steel Players

Last month, some of the prominent steel producers came up with a cheerful guidance for the March quarter. Nucor Corporation said that it expects first-quarter earnings of $3.00-$3.10 per share, reflecting an increase from $1.30 in the prior quarter and 7 cents in the year-ago quarter. The projected first quarter earnings are expected to exceed the previous record set in the third quarter of 2008 and be the highest quarterly earnings in the history of Nucor. The company’s steel mills and raw materials segments benefited from strong steel demand and higher prices. Nucor expects the performance of these units to be considerably higher on a sequential basis in the first quarter. Steel Dynamics also provided an overwhelming view for the first quarter. It envisions earnings of $1.88-$1.92 per share that suggests an increase from 89 cents in the previous quarter and 88 cents in the prior-year quarter. Adjusted earnings for the quarter have been forecast at $1.94-$1.98 per share, which Steel Dynamics expects could be a record figure. The profitability of the company’s steel operations for the first quarter is forecast to rise considerably on a sequential basis led by flat roll metal spread expansion, as prices of flat roll steel remain supported by strong demand. Steel Dynamics also expects steel shipments to rise sequentially across its portfolio. Moreover, United States Steel Corporation bumped up its earnings view for the first quarter factoring in strong market conditions. The company raised adjusted earnings per share outlook to $1.02 for the quarter from 61 cents communicated earlier. U.S. Steel noted that solid market fundamentals and its well-timed acquisition of Big River Steel are backing significant earnings growth. It expects to benefit from healthy flat-rolled customer demand across most end-markets and flow-through of higher steel prices. Cleveland-Cliffs also issued strong guidance for the first quarter that exceeded analyst expectations. The company sees first-quarter adjusted EBITDA of roughly $500 million.

Now, somebody on the outside looking in would say that this year, meaning 2021, could be peak EBITDA, peak earnings, etc., and cyclical companies naturally trade at low valuations at the peak of their cycles.

This is true for cyclicals, especially those at all-time highs, however, in the case of U.S. Steel, the valuation is still compelling, because it's not pricing in a higher base level of steel prices, let alone the front loaded boom in earnings and free cash flows that will imminently be delivered into the coffers of its owners/shareholders in the upcoming year.

With regard to earnings estimates, they have increased from $0.14 approximately 90 days ago to $4.13 now, as the table below illustrates, however, I think this vastly understates their earnings potential this year.

(Source: Yahoo Finance)

In fact, with the current level of steel prices, I think U.S. Steel could earn $8 to $10 per share this year, in 2021, which seems farfetched right now, however, consider how much earnings estimates have risen the past 90 days.

With a stock price of roughly $22 as I write this article, an owner could potentially recoup a significant amount of the price paid for a share in earnings in a single year, this year.

Adding to the bullish case, earnings estimates are far too low for 2022 right now, and these will rise aggressively as the confidence in the durability in steel price gains is strengthened.

In summary, since we are in the early innings of a upturn in commodity prices, there is wide degree of uncertainty around future earnings and cash flows, and that is creating a still compelling entry point today.

Closing Thoughts: We're In The Early Innings Of An Upturn In Commodity Prices and Commodity Equities

For much of the past decade, disinflationary assets, including a large portion of the S&P 500 Index, have ruled the roost, as the broader U.S. equity market benefited from abundant labor availability following the 2007-2009 financial collapse and declining raw material costs, especially as a percentage of their sales. These two trends led to superior profit margins, however, we're in a different environment today, where wage inflation is running at its fastest pace in over a decade, and commodity prices are surging, partially due to a lack of investment the past decade.

From a bigger picture perspective on commodities, this is the capital cycle at work.

(Source: GMO)

Specific to steel prices, we're certainly seeing high commodity prices at the present time, and we're getting to elevated valuations and supply coming online, however, since the past decade was so brutal, there was not that much spare capacity to bring back online. In fact, in the U.S., I think every facility that can produce steel is incented to operate at full capacity today, and demand is still outpacing supply.

This is going to lead to multiple expansion, and the companies that acquired assets at the bottom of the cycle, specifically Cleveland-Cliffs and U.S. Steel, are set to benefit the most. Right now, market participants are still waking up to this reality, and that's why there's still considerable appreciation potential, particularly in U.S. Steel shares today, which could trade for far lower multiples than many investors expect, as analyst estimates catch-up to the ongoing pricing reality.

Bigger picture, commodity equities, in particular, are still very cheap and out of favor, even if they have risen from the bargain-basement levels of August 2020.

(Source: Longview Economics, Macrobond)

For much of the past year, I have been pounding the table on the extremely out-of-favor commodity equities for a long time now, and I still think we're in the early innings of what will be a longer-term price appreciation. Investors skittish of the commodity sector should research cast aside financials as they also will benefit from rising inflationary expectations and rising long-term interest rates. Understanding the bigger picture, then having an understanding of the bottoms-up fundamentals has been the key to outperformance, and this is a path that has not been easy with those participating confirming this reality. However, the road less taken is sometimes the better one, and I firmly believe that today, as traditional stocks, bonds, and real estate offer very poor starting valuations, and very poor projected future real returns, from today's price levels. More specifically, the out-of-favor assets and asset classes, including commodities and commodity equities, and out-of-favor specific securities are where the historic opportunity has been, and that's where it still stands, from my perspective.

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.

This article was written by

KCI Research Ltd. profile picture
27.35K Followers
Author of The Contrarian
"Against the grain" investing backed by real-world wisdom and experience
Founder of "The Contrarian", a premium research service, featuring a committed, collegial group that has uncovered a number of hidden gems, hidden in plain sight.  Immensely proud of what our members have accomplished.  Actively investing since 1995, I have soared like an eagle, and been unmercifully humbled by the markets. Achieved positive returns in 2008, and turned an account with $60,310 on 1/1/2009 into an account with $3,177,937 on 11/30/2009. My best years have been 1995-2003, 2008-2012, 2016, 2020, & 2021. My worst years were 2013-2015 & 2017-2019. I believe inflation is coming, and we are at an inflection point in the markets.


Twenty plus year career as an investment analyst, investor, portfolio manager, consultant, and writer. Founder of Koldus Contrarian Investments, Ltd, which was incorporated in the spring of 2009. Dyed in the wool contrarian investor, who has learned, the hard way, that a good contrarian is only contrarian 20% of the time, but being right at key inflection points is the key to meaningful wealth creation in the markets. I believe we are near a meaningful inflection point, perhaps the biggest one yet, for the third time in the past 15 years.


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

"A diamond is a chunk of coal that is made good under pressure."

Henry Kissinger

"Knowledge is limited. Imagination encircles the world." Albert Einstein

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, CLF, AND SHORT 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 a 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.

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