United States Steel (X -3.53%) posted losses of over $26.50 a share cumulatively between 2009 and 2013, a stretch during which the company didn't manage a single year of black ink. The stock, meanwhile, is down over 75% since peaking in mid-2008. However, now could be a good time for long-term investors to take a look at this down-and-out steel giant.
Those were the days
In the first decade of the 2000s, China was growing at double-digit rates. The country's largely agrarian economy was shifting toward an industrial one, with people moving from the countryside to the city -- a huge shift leaving China little choice but to build quickly to accommodate the urban migration.
Building cities and supporting infrastructure requires products like steel. With massive demand, prices for steel were heading higher across the globe as China sopped up virtually all of the world's supply, and capacity increased to meet what seemed like never-ending demand. Unfortunately, that level of demand has proved unsustainable. China's growth has slowed, and with it global demand for steel, leaving excess capacity that foreign steel makers have sold into the U.S. market at unfairly low prices. Thus the five-year (and counting) trip through red ink for U.S. Steel and competitors like AK Steel (AKS).
The recent anti-dumping levies imposed by the United States on oil country tubular goods (oil drilling pipes) is a prime example. This is a key segment for U.S. Steel and a growing industry, however it expects the glut of imports to leave sales roughly flat year over year. Although this one segment only makes up about 15% of U.S. Steel's business, it is a clear-cut example of the impact that global overcapacity driven by a slowdown in Chinese demand is having on a company that doesn't sell to Asia. In fact, according to the company, "imports remain challenging" in this business segment even after government action.
Leverage
Some companies using more efficient steel technology, like Nucor's (NUE -1.08%) electric arc furnaces, managed to quickly get themselves back into the black after demand slowed. But U.S. Steel and AK Steel both make steel using blast furnaces and have legacy issues to deal with, like unions. That makes it harder for them to turn a profit during lean times because of the high fixed costs they face. However, once their elevated costs are covered, profits flow pretty quickly from the top line to the bottom.
For example, U.S. Steel earned more than $7 a share in each of the five years leading up to and including 2008. It broke into double digits twice in that span. Moreover, the company's gross margins have recently been stuck at around 8%, but they were more than twice that in four of the five years before the string of losses.
So when times are good, U.S. Steel can earn a lot of money. That's not happening right now, but don't look at the current trend and extrapolate. That didn't work on the upside, and it won't work on the downside.
Supply and demand
For starters, steel demand isn't the big issue right now. In fact, ArcelorMittal (MT 0.04%), another steel giant that's been struggling, expects global demand to be at least even with last year's tally at around 3.5% or so. Increased demand from developed nations is making up for slowing demand in developing ones. That's great news for U.S. Steel, which basically operates in the United States and Europe. The competition U.S. Steel faces is largely from low-priced imports into its core markets.
However, that's an increasingly positive story, as well. As steel prices have fallen, it has become harder for high-cost operators to turn a profit. Foreign governments have been lending their steel makers an unfair helping hand, according to U.S. Steel, Nucor, and AK Steel, among many others. But that's starting to change, too. For example, China, one of the biggest offenders according to Nucor, has been talking about closing unprofitable steel mills. And the country appears much more willing to allow failing companies to fall into bankruptcy than in the past.
In addition, U.S. Steel has used this downturn to close its own high-cost operations and to introduce new technology into its production processes (including plans to open a low-cost electric arc operation). U.S. Steel is a leaner and meaner company today than it was when the downturn started.
Investors have clearly taken note of the positives, sending the shares up over 100% in the last 12 months -- but it got hit harder than its peers, so that isn't as concerning as it first appears on the valuation front since it's just making up lost ground. More troubling is U.S. Steel's 1.6 price to book value, well above the industry's 1.0. This suggests it isn't cheap, unless you're taking a long-term view.
U.S. Steel is leveraged to an industry upturn that appears to be taking shape. And during the last industry upturn, the company's price to book value peaked at 2.6 times (2007), suggesting there's still room to run as industry supply and demand balance out.
