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 best...
Things are looking bleaker for world steelmakers (if that's even possible) this week. Yesterday, an analyst at Axiom Capital announced it was initiating U.S. Steel (NYSE: X  ) with a sell rating and a $10 price target. On the one hand, you might say this is just another opinion, at worst canceling out the positive sentiment that analysts at Imperial expressed last week. On the other hand, this is Axiom we are talking about.

As in, the folks who warned us that the solar stocks were about to melt down, before it happened.

Axiom's not exactly a household name among retail investors. Historically, its ratings haven't been reported via Briefing.com, or gotten much attention in the mainstream press. Perhaps for this reason, many investors laughed off the analyst's concerns in years past, even chuckling that Axiom was "always wrong on the bearish side of things." Sadly for solar investors, it was the bulls who turned out wrong.

With shares of former solar stars such as First Solar, Trina Solar, and Suntech down anywhere from 70% to 90% over the past year, no one's laughing at Axiom now. The question today, though, is whether this analyst will prove as prescient about steel stocks as it was about solar.

Let's go to the tape
Before we get to the details of Axiom's report, let's review a few numbers for a few of the major players in global steel, and see how things currently stand:

Company

P/E

Growth Rate

Free Cash Flow

Net Debt

ArcelorMittal (NYSE: MT  ) 134 26% $1.3 billion $22 billion
Nucor (NYSE: NUE  ) 22 9% $575 million $2.6 billion
Steel Dynamics (Nasdaq: STLD  ) 18 10% $224 million $2 billion
U.S. Steel N/A 6% $147 million $3.5 billion
AK Steel (NYSE: AKS  ) N/A 19% ($265 million) $1.3 billion

So looking at these numbers, a few things jump right out at us. Debt levels are relatively high in this capital-intensive industry. Profits -- for those lucky enough to earn them -- are fairly low. Indeed, profits are so low that not even the high growth rates that Wall Street is currently predicting suffice to generate attractive PEG ratios for any of the companies discussed.

On the other hand, free cash flow does appear to be turning around. All but one of the major players (AK) currently generates positive cash profits, a trend that could help them survive their debt burdens. That's the bull case -- the best face I can put on the situation, giving these firms every benefit of the doubt. The bear case, as Axiom explains, is quite a bit worse:

"Our analysis [suggests that] every +/-1% move in X's hot-rolled steel price impacts underlying earnings by ~$0.44/share."

And how's that working out for U.S. Steel, you ask? "Hot-rolled steel prices are down -9% YTD."

Uh-oh
I know. And it gets worse: Analysts on Wall Street are still expecting hot-rolled steel to sell for $726 a ton this year, but in fact, futures prices on the stuff currently stand at only $635/ton, while Axiom notes that the market is still "structurally oversupplied" with cheap steel from China. Result: As the analyst laments, "despite boasting a cost advantage due to its own iron ore, X has consistently fallen short of its implied operating profit-per-ton."

Exacerbating the problem, U.S. Steel operates at an "overwhelming structural cost disadvantage versus its U.S. steel peers due to its overbearing pension liability, which was $5.2bn exiting '11." You'll note that this number is even higher than USX's "net debt" level, listed up above -- meaning pension obligations are an even bigger burden for the company than its actual debt obligations.

Foolish final thought
Now it's possible that Axiom is wrong about U.S. Steel. It's possible that I'm wrong, too. Free cash flow trends are turning around in this industry (although they could turn around yet again). Steel prices could rise to the levels Wall Street has predicted (although the Street has been consistently wrong about this for at least the last 13 months), and if that happened, the "$0.44/share" effect that Axiom mentions would logically work for USX rather than against it.

Long story short, though, I'd rather be short this stock than long. And to put my reputation where my mouth is, I'm taking advantage of yesterday's share-price-spike to publicly rate U.S. Steel an "underperform" on CAPS. Want to see how the pick works out? (To be honest, I'm kind of curious myself). Click this link, and follow along.

Meanwhile, more adventurous investors can avoid the steel guessing game altogether, and invest instead in the next new revolution in manufacturing. To find out how, read the Fool's new report on: "3 Stocks To Own For The New Industrial Revolution aka The Future is Made in America." It's free today, but it won't be for long, so make sure to click quickly.

The Motley Fool owns shares of ArcelorMittal, but Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 308 out of more than 180,000 members. The Motley Fool has a disclosure policy.

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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