This Just In: More Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." The pinstripe-and-wingtip crowd is entitled to its opinions, but we have some pretty sharp stock pickers down here on Main Street, too. And we're not always impressed with how Wall Street does its job.

Perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. But in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

Susquehanna takes a shine to steel
Two weeks ago, we took a look at Deutsche Bank's surprising move into steel stocks, as the German megabanker upgraded shares of both U.S. Steel (NYSE: X  ) and AK Steel (NYSE: AKS  ) to "buy." According to Deutsche, prices of steel are approaching a floor, and steelmakers are ready to bounce "in anticipation of steel price and demand inflection." Turns out that's a popular view.

This week, an analyst a bit closer to home (and closer to the steel stomping grounds) is seconding Deutsche's emotion. Characterizing itself "positive" on Big Steel, Susquehanna Securities initiated coverage of the steel sector Wednesday. Susquehanna rated two of the bigger names in steel -- Nucor (NYSE: NUE  ) and Commercial Metals -- only "neutral," but aside from those two, the analyst likes pretty much everybody in the industry:

  • U.S. STEEL: positive, with a $58 price target.
  • AK Steel: likewise, and targeted for $20.
  • Steel Dynamics (Nasdaq: STLD  ) : ditto at $21.
  • and Cliffs Natural Resources (NYSE: CLF  ) : positive and pegged for $130 a share.

In the interests of rounding out the list, I should mention that on Tuesday, Forbes' pocket analyst, the "Trefis Team," announced that it is also bullish on the world's biggest steelmaker, ArcelorMittal (NYSE: MT  ) on news that it's bidding with Peabody (NYSE: BTU  ) to acquire control of Macarthur Coal.

"Great" minds think alike
Like Deutsche, Susquehanna seems to take a particular shine to U.S. Steel and AK Steel. The analyst believes that investors aren't seeing the full value of U.S. Steel's North American iron ore assets, for example, and argues that the company also has the most leverage to steel prices in the entire industry. If Susquehanna is right, then a rise in prices (some analysts say we could see $700 a short ton within the next 12 months) would disproportionately benefit the company. Meanwhile, the analyst sees improved earnings power in AK's future as "lower future employee benefit liabilities and a better cost structure" begin to improve profit margins.

Steel stocks: Buy the numbers?
Is Susquehanna right? It's hard to say. This is, after all, the analyst's first foray into steel stocks, so it's anybody's guess whether Susquehanna will prove proficient in this particular sector of the economy. So far, however, our CAPS records show that Susquehanna has only about a 50/50 record in getting recommendations right over the five years we've been tracking its performance.

Call me a pessimist, call me a Fool -- but I'm not optimistic. Fact is, out of the four stocks that Susquehanna assured us are "buys" yesterday, I honestly see only one that has any real promise.

U.S. Steel
Is it U.S. Steel, granddaddy of the industry? You know better. As I described last month, U.S. Steel isn't in the habit of rewarding investors. Over the past five years, this company has reported earning $2.5 billion in GAAP "profits" -- but generated only $1.1 billion in actual free cash flow. It's done even worse more recently, reporting $411 million in GAAP losses and burning through well over $1 billion in negative free cash flow.

AK Steel
Same story with AK -- but more so. Here we have a steelmaker that's claimed $200 million in net profits earned over the past five years … while burning $14 million in negative free cash flow. Once again, recent trends are even bleaker. Trailing-12-month results show AK down $122 million under GAAP and $579 million in the hole from a free cash flow perspective. In valuation terms, neither AK nor U.S. STEEL stock is worth the paper their stock certificates are no longer printed on.

Steel Dynamics
What about Steel Dynamics, then? There's a bit more hope with this one. For one thing, the company is GAAP-profitable for the past year. For another, unlike the legacy steelmakers, Steel Dynamics has a demonstrated history of cash production. From 2006 through 2010, the company didn't suffer a single FCF-negative year. It's currently free cash flow-negative for the trailing-12-month period, however. Maybe I'm being overcautious here, but I'm not ready to buy in just yet.

Sell the steelmakers -- but the guys who sell to the steelmakers
No, if you ask me, the best play on steel today is in Cliffs Natural Resources -- an iron and coal miner that sells to Big Steel. The company doesn't generate quite as much free cash flow as it claims for net income, ordinarily -- but with more than $1 billion in cash generated over the past year, I think it's close enough for government work. Meanwhile, Cliffs is selling for the low, low price of just 10.3 times earnings and 13.5 times FCF -- earnings that most analysts expect to grow 27% per year over the next five years.

Cliffs Natural Resources looks like a real bargain at today's prices. Out of the four steel stocks Susquehanna pitched us this week, this miner is the only one I might actually buy.

Fool contributor Rich Smith does not own shares of (or short) any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 567 out of more than 170,000 members.

The Motley Fool owns shares of Nucor, and Motley Fool newsletter services have recommended buying shares of Nucor.

We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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