Is a Recovery Around the Corner for These 2 Steel Stocks?

U.S. Steel and ArcelorMittal both see recoveries ahead, but their stock prices are down to start the year. What gives?

Jul 6, 2014 at 3:33PM

Steel is a highly cyclical industry that is closely tied to the rate of global economic growth. This relationship means steel companies enjoy rapid growth when the economy booms. But, unfortunately, the reverse is true as well. When the economy sputters, the steel industry usually goes south.

It's no surprise then, that the entire steel industry in the United States was brought to the brink of total collapse during the 2008 financial crisis. Fortunately, several years removed from the recession, there are glimmers of hope appearing throughout the steel sector.

For example, United States Steel Corp. (NYSE:X) swung to a first-quarter profit, reversing a loss incurred in the same quarter last year.

But if there's a recovery afoot for U.S. Steel, you wouldn't know it by its stock price performance this year. The stock is down 11% since the beginning of the year, implying a pervasive pessimism about what the future holds. And it's true, despite some notable signs of improvement, steel producers may have a ways to go before their turnarounds are for real.

Signs of a steel turnaround?
U.S. Steel posted a first-quarter profit of $52 million, or $0.34 per diluted share. This completely reversed the $73 million loss from the same quarter last year. The major difference-maker this time around was U.S. Steel's flat-rolled segment. Last year, this unit posted a $13 million loss. This time around, U.S. Steel generated an $85 million profit in that business. This more than offset weaker results in both of its other key segments, U.S. Steel Europe and tubular.

U.S. Steel realized the benefits of both higher average realized prices and shipments in its flat-rolled segment. In addition, the company saw reduced repairs and maintenance costs that had kept profitability down in prior periods.

European steel giant ArcelorMittal (NYSE:MT) is enjoying some of the same benefits too. Its own first quarter was helped by 2% higher steel shipments. However, ArcelorMittal still lost $200 million in the first quarter, although that did represent improvement both year over year and sequentially. ArcelorMittal lost $345 million in the same period last year, and $1.2 billion in the fourth quarter of 2013.

In addition, U.S. Steel has a strong balance sheet. At the end of the last quarter, the company held $1.1 billion in cash on the books. This provides a good margin of safety against fluctuating economic conditions.

Outlook tells the story
The reason why U.S. Steel's stock is down even though it went into the black in the first quarter is its near-term outlook. Management expects operating profit to fall in the second quarter, due to lower expected shipments. The company is still incurring weather-related logistical issues that are having an effect on production. As a result, management forecast calls for the flat-rolled segment to report a loss.

That being said, U.S. Steel believes these complications are temporary, and notes market conditions in North America are improving. Because of this, the current-quarter problems are not expected to last throughout the remainder of the year.

Likewise, ArcelorMittal is positive about what the future holds. Management believes it can generate $8 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) this year, which would represent 16% growth versus 2013, based on rising shipments of steel and iron ore as well as an improvement in steel margins.

The market isn't as convinced
The earnings reports out of major steel producers like U.S. Steel and ArcelorMittal are fairly optimistic, especially given the operating challenges that continue to weigh on profitability. Despite management teams of both companies promising better performance ahead, it seems investors aren't so sure. Share prices of both stocks are down so far to start the year, despite first-quarter earnings that were measurably better than the same period last year.

As a result, you'll need to have nerves of steel to buy U.S. Steel and ArcelorMittal. But if their turnarounds materialize as expected, they just might be able to prove their doubters wrong.

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