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.

Gird yourself for the Great Steel Sell-Off of 2012
Buy U.S. Steel (NYSE: X  ) and AK Steel (NYSE: AKS  ) in August 2011. Then buy some ArcelorMittal (NYSE: MT  ) in November 2011. It's March 2012? Then it must be time to buy Nucor (NYSE: NUE  ) and Steel Dynamics (Nasdaq: STLD  ) as well. For nearly a year now, the steel bulls at UBS have been telling investors that an industry recovery is just around the corner. It was getting so that you might think there's never a bad time to buy steel.

Until this week.

The months of August, November, and then March may all have been great months to buy steel -- or they may not have been...

AKS Chart

AKS data by YCharts

...but it's starting to look like June may be the month for steel investors to sell. After reaping nothing but losses for its clients for months on end, UBS finally threw in the towel yesterday -- and the first stock to get snapped with it was AK Steel.

Lamenting "underwhelming" guidance on Q2 steel production, and warning that AK's joint venture with Minnesota's Magnetation LLC "could drag operations until a pelletizing facility is added and we believe AKS is underestimating pelletizing capex," UBS finally conceded yesterday that "pricing [will get] worse before it gets better and AKS has significant leverage to pricing." Toss in a few concerns about pricey pension obligations, and you've got the stage all set for a downgrade to neutral.

The beginning of the end
And this could be only the beginning. Despite going bearish on AK, UBS remains for the time being bullish on rivals Steel Dynamics and U.S. Steel, which the analyst believe "have fewer issues (balance sheet and overall structure) and are therefore better plays." But even if the analyst is right about this, "fewer" is not the same as "none." With $1 billion net debt against a market cap of just $600 million, AK's isn't in great shape, no doubt, but its peers aren't doing much better.

Profitless U.S. Steel bears a net debt load $1 billion more than its market cap. The fact that neither of these steel majors seems capable of generating real free cash flow in the current economy doesn't help matters.

Best of the bad
Of those remaining, Steel Dynamics is the stock with the best cash flow -- $310 million in positive free cash flow left over after deducting capital expenditures -- while Nucor also lands well in FCF-positive territory.

If AK's downgrade truly does mark a new inflection point in Street sentiment for the steelmakers, these are the two stocks to focus on. Neither one looks like a particularly compelling value to me today, but in the midst of a market panic and a sell-off of steel stocks, they could become bargains right quick. If investing in heavy industry is what you're here for, make sure to take a peek into the future of manufacturing with our new free report "3 Stocks To Own For The New Industrial Revolution, aka The Future is Made in America."

Fool contributor Rich Smith does not own, or short, any of the companies named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 339 out of more than 180,000 members. The 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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