Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Steel prices are sliding.
Costing $633 a ton at the start of this year, prices for hot rolled steel coil have dipped steadily toward the $600 level all year long (they're at $613 now). Investment banker Credit Suisse says you can expect to see steel prices keep on sliding, too, all the way down to $580 a ton (more than an 8% drop from January) -- and then stop.
As it turns out, then, this is actually good news for steel stocks. As reported this morning on StreetInsider.com, Credit Suisse foresees an end to declining steel prices sometime this summer. That's why today, the Swiss banker announced it is upgrading shares of Nucor (NUE 6.21%), Steel Dynamics (STLD 6.01%), and U.S. Steel (X 5.53%), too -- to buy.
Here are three things you need to know about that.
1. Why steel looks shiny
Credit Suisse isn't just predicting an end to falling steel prices this summer, you see. In fact, the analyst predicts that steel prices will go up -- recovering ground lost earlier this year "by late 3Q." Demand trends, says the analyst, "remain strong," while inventories are "low." And while imported steel continues to pressure prices among U.S. steelmakers, Credit Suisse points to a national security investigation by the Trump administration under Section 232 of the Trade Expansion Act of 1962, which has the potential to impose tariffs on and limit imports of foreign-made steel.
By raising the cost and limiting the availability of imported steel, these actions could permit U.S. steel manufacturers to raise their own prices -- putting steel prices back on an upward trend.
As the "most capital efficient US steel company," Credit Suisse expects Steel Dynamics to benefit disproportionately from rising steel prices. Fixed costs will quickly be covered and any growth in prices should drop immediately to the bottom line. Adding to the analyst's optimism, Credit Suisse notes that Steel Dynamics has been investing in production of higher-margin products.
2. Nucor looks second best
Meanwhile at Nucor, Credit Suisse notes that the steel minimill operator "has the most exposure to late cycle construction and infrastructure markets and is uniquely positioned in the US plate market." This makes Nucor uniquely positioned to benefit from an eventual Trump administration push to grow infrastructure investment -- which hasn't materialized yet, but still might.
If and when Trump's ballyhooed $1 trillion infrastructure investment program materializes, Credit Suisse expects this to "drive meaningfully higher EBITDA performance for Nucor's long product and plate segments, which account for ~50% of total shipments." This, in the analyst's view, justifies assigning an outperform rating to Nucor stock.
3. Last but not least: U.S. Steel
And finally we come to Credit Suisse's bull case for U.S. Steel. It's a bit less enthusiastic than the cases Credit Suisse makes for the other two steelmakers. Still, in this banker's view, "less operational disruption" from imported steel, combined with "volume leverage" (as U.S. Steel presumably gets to sell more steel of its own to fill the gap) will increase U.S. Steel's earnings power next year.
Credit Suisse forecasts that U.S. Steel will enjoy "~$200mm" of extra earnings before interest, taxes, depreciation, and amortization (EBITDA) from the sale of steel pipe, which will help to replace the "~$150-200mm of headwinds in the Flat Rolled division we forecast in 2017." Net-net, that should help U.S. Steel to at least break even over the course of these two years -- and help U.S. Steel stock to recover some of the value it lost after the company reported weak earnings last month.
So which steel stock should investors buy?
Of the three steel stocks it upgraded this morning, Credit Suisse actually sees the greatest profit potential in the weakest-performing steel stock -- U.S. Steel. According to the banker's estimates, if U.S. Steel hits its $29 price target, investors stand to earn profits of as much as 37% on an investment made today. That compares nicely to the 22% profit potential if Steel Dynamics goes to $43 (as Credit Suisse predicts it will) and the 16% potential profit from Nucor rising to $68 a share.
So which of these three stocks should you buy in hopes of a turnaround in steel prices? I'm inclined to go with the middle of the three potential profits than Credit Suisse is predicting: Steel Dynamics. Priced at 16.6 times trailing earnings, Steel Dynamics is the cheapest of the three steel stocks named. (Nucor costs more than 17 times earnings, while U.S. Steel, unprofitable, has no P/E ratio to speak of.)
Growth-wise, both Nucor and Steel Dynamics look attractive, with Nucor's projected earnings growth of 26% annually over the next five years resulting in a very attractive PEG ratio of 0.7, and Steel Dynamics selling for a PEG of less than 1.0. (U.S. Steel does not look attractive at just 8% projected growth -- and no profits to grow.)
Arguably, this makes Nucor the cheaper investment. But personally, I'd rather bet on Steel Dynamics' goal of 17% annualized earnings growth than the moonshot growth of 26% that Wall Street projects for Nucor. It just seems more attainable. That, plus the cheaper P/E, makes Steel Dynamics look like the better buy to me.