Steel stocks went on a tear last week -- and Wall Street noticed.
After seeing iconic steel stocks like U.S. Steel (X) tack on gains of 30% and more over the course of just a few days, investment banker Morgan Stanley wasted no time in hopping aboard the steel train. This morning, the analyst announced upgrades to overweight on both U.S. Steel and smaller rival AK Steel (AKS), then threw in an upgrade for iron ore producer Cliffs Natural Resources (CLF -1.25%) as well (and Cliffs stock was already up 23% through the end of last week, itself).
What's with all the excitement about steel stocks all of a sudden? In a word: Trump.
Here are three things you need to know.
1. President-elect Trump is yuge news for big steel
As TheFly.com explains in a write-up on Morgan Stanley's upgrades this morning, Donald Trump's electoral victory last week created the first "credible long-term investment case" for steel stocks "in a decade." It does so for two main reasons.
The first, as my Foolish colleague Jason Hall explained last week, is because President-elect Donald Trump has promised to protect American companies such as U.S. Steel and AK Steel from unfair competition from abroad. As Jason points out, [I]mports, particularly from Asia, have flooded the domestic market and put serious pressure on steel plants in the U.S. to operate profitably." At times, as much as 30% of the steel being used in America has been of the imported variety -- severely limiting American steel companies' ability to maintain profitable prices on their product.
Investors such as Morgan Stanley expect Trump to put a stop to that, perhaps through the expedient of raising import tariffs on foreign-produced steel.
2. The second reason
More broadly, optimism over steel stocks stems from a general belief that the incoming Trump administration will emphasize infrastructure investment. After all, at his core, Trump is a builder (of hotels, and potentially, of walls). Construction projects create a huge appetite for such commodities as concrete, asphalt, and...steel. And this promises to be good for business at U.S. Steel and AK Steel.
At the same time, farther up the supply chain, another of my Foolish colleagues -- Todd Campbell this time -- points out that "Cliffs Natural is the country's biggest producer of iron ore pellets used in steel production." Morgan Stanley doesn't see Cliffs stock as quite the bargain it believes U.S. Steel and AK Steel to be, but it still likes Cliffs a whole lot more today than it did before.
3. How much does Morgan Stanley like them?
Time to get specific. How much does Morgan Stanley like these three stocks, and which does it like best?
While both AK Steel and U.S. Steel get the thumbs up from MS, U.S. Steel appears to be its favored choice. The analyst nearly tripled its price target on U.S. Steel stock this morning, from $19 to $46. At a current share price of $25 and change, that works out to nearly 79% upside potential on the stock.
AK Steel comes in at second best. Here, Morgan Stanley barely doubled its price target from $5 to $11. With AK Steel stock selling for $7.50 as of this writing, that still works out to a very respectable 47% potential gain on the stock.
As for Cliffs Natural Resources stock, Morgan Stanley again tripled its price target, but only from $3 to $9. With Cliffs costing $7.60 today, that implies there's a possible 18% profit to be made. Ordinarily, that would be enough to catch any investor's eye. But given that Morgan Stanley sees such bright prospects farther down the supply chain, at the steelmakers themselves, the analyst sees Cliffs as a third-place option, and rates the stock only equal weight.
Final thing: Which stock should you choose?
That actually makes sense to me, and not just because of the differences between what Morgan Stanley seesas the stocks' potential valuations a year from now. You see, while data from S&P Global Market Intelligence shows that all three of these companies are free-cash-flow-positive today, both AK Steel ($178 million) and U.S. Steel ($269 million) are generating more cash profit than is Cliffs Natural Resources ($101 million). AK Steel and U.S. Steel also sport lighter debt loads than does Cliffs, and on larger market capitalizations,jh to boot.
Finally, while Morgan Stanley sees strong prospects for growth at all three stocks under a Trump administration, the consensus of analysts polled on S&P Global is that the growth rates we'll see at AK Steel and U.S. Steel over the next five years are both going to be twice as fast as what Cliffs Natural produces.
All of which adds up to stronger buy arguments for the two actual steel stocks, than for the one company that supplies them with ore.