U.S. Steel is pulling out of a long slump -- and how. Shares have soared 70% in the past three months. Investors looking to book profits, however, might want to hold off, given that one investment bank expects the stock to rise more than 50%.
Few companies have fallen further in economic might than U.S. Steel (ticker: X). In 1901, when it was founded in a massive roll-up of rival steel makers, investors valued the company at an amount equal to nearly 7% of America's gross national product. By that measure, "The Corporation," as it became known, was about twice as big as Apple today.
Earlier this summer, U.S. Steel was demoted from the Standard & Poor's 500, an index of large U.S. companies, to the S&P MidCap 400. The reversal of fortune speaks to America's long competitive decline in steel. Last year, U.S. Steel was still the top domestic producer, but it was only No. 13 worldwide.
Suddenly, however, the shares are surging again. They opened 4% higher on Wednesday, at $39.69, and are up 50% since the end of June. Earnings estimates have been climbing for this year and next. On Wednesday morning, Morgan Stanley published a note describing a "paradigm shift" in domestic steel, which will bring more stable pricing, higher profit margins and loftier stock valuations. It wasn't subtle in its forecast for U.S. Steel, dramatically raising its price target to $60 from $35.
Morgan Stanley (as in Henry Morgan, the grandson of U.S. Steel founder J.P.) cites five pieces of good news for both U.S. steel and U.S. Steel.
First, deal-making is reducing competition, similar to what has happened in the airline industry. The top five flat-rolled steel players have 80% market share, up from 70% in 2011. There are fewer small players willing to sacrifice profits in order to gain scale.
Second, demand is rising, driven by car sales, nonresidential construction, and oil and gas drilling. Morgan Stanley predicts 4.5% steel demand growth this year, accelerating to 6.6% next year.
Third, wholesale steel inventories are lean, and will need to be topped up.
Fourth, steel mills have only just reached 80% capacity utilization, a key level for surging profitability, and should reach 85% by 2016. Mill closures have helped; more than 7% of U.S. mill capacity has been closed or idled since 2012.
Fifth, imports look unlikely to spoil the party. Recent and ongoing antidumping and other trade cases are likely to keep import pricing more rational than in the past, while shipping costs are expected to soar next year on limited shipbuilding and bumper grain harvests.
U.S. Steel has lost money since the global financial crisis, but new management that was put in place last year is overhauling the business under a plan called Project Carnegie, which involves cutting costs and pruning struggling operations. So far it has saved $460 million in yearly costs, an amount that would have closed losses over the past five years by more than half.
Wall Street expects the company to return to profitability this year, earning $2.14 a share. That puts the stock at 18.4 times earnings. Over the next three years, earnings per share are expected to nearly double, putting shares at 9.3 times the 2017 forecast. A $60 price would put shares at 14.1 times the 2017 estimate -- assuming Wall Street doesn't continue to ratchet its earnings expectations higher.
Source: online.barrons.com
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