This Just In: 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." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the worst...
Will they ever learn? Last month, a raft of earnings warnings emanated from the likes of Nucor (NYSE: NUE  ) , Steel Dynamics (Nasdaq: STLD  ) , and AK Steel (NYSE: AKS  ) . But disregarding the warnings, Swiss banker UBS insisted the time to buy U.S. Steel (NYSE: X  ) was now (i.e., then). All the bad news just couldn't shake UBS' opinion that the steel industry turnaround that they'd so long awaited had arrived.

Well, it didn't -- but it may soon. Last week, Nucor reported that with profit margins shrinking, it earned less profit despite selling more steel. USX then echoed that news with a reported loss two-and-a-half times worse than in last year's first quarter. And AK's report was perhaps worst of all, as its year-ago profit fell apart and resulted in an $0.11-per-share loss in first-quarter 2012.

Not that UBS cares. They're still totally in the tank for big steel... and this time, they may be right.

Still stumping for steel
Yesterday, Nomura pointed to increased "utilization" of U.S. Steel's production capacity (to 81%) as indicative of revived fortunes at the company. Even absent increases in the price of steel per ton, Nomura thinks "solid volume performance" could be enough to get the company back in the black.

Joining Nomura in the steel bullpen, UBS argued in favor of continuing to buy U.S. Steel, even as it ratcheted back its price target slightly, to $46 per share. According to UBS, by cutting coking coal consumption and capitalizing on a need for pipe to support increased oil drilling activity in the U.S., USX will earn $3.05 per share this year.

This argument has some basis. After all, both USX and AK Steel believe they'll return to GAAP profitability this current quarter. This suggests that the inflection point UBS has been awaiting so long may finally be near. Indeed, it may already be here. If not for charges that USX took for closing a steel plant in Serbia, the company would have been profitable last quarter. Best of all, my main reason for avoiding USX in the past -- negative free cash flow -- appears to be reversing as well.

Valuation matters
Make no mistake: On a trailing-12-month basis, U.S. Steel remains firmly free-cash-flow negative (as do AK and ArcelorMittal (NYSE: MT  ) , for that matter. Currently, the FCF-positive club contains just two big members -- Steel Dynamics and Nucor). But last quarter, at least, USX managed to generate positive free cash flow of $240 million. If it can keep that up in future quarters -- not even keep improving, but merely maintain the level of profitability it achieved in Q1 -- this company could be generating cash profits at close to $1 billion annually by the end of this year.

Valuation-wise, this suggests that currently unprofitable and cash-burning USX could soon evolve into a company generating so much cash as to give it a price-to-free cash flow ratio of four (at today's share price). It doesn't take much growth to justify that kind of uber-low valuation. In fact, the 6.5% long-term growth projection that Wall Street posits for USX should do just fine.

Where are the smartest investors finding their own bargains? Find out in the Fool's new (and appropriately titled) report: "The Stocks Only the Smartest Investors Are Buying." It's free for download today, but won't be for long -- so make sure to click quick.

Fool contributor Rich Smith does not own shares of, nor is he short, any company mentioned above. He does, however, have public recommendations available on more than 50 separate companies. Check them out on Motley Fool CAPS, where he goes by the handle "TMFDitty" -- and is currently ranked No. 349 out of more than 180,000 CAPS members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of ArcelorMittal. Motley Fool newsletter services have recommended buying shares of Nucor. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


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