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...
So far this year, shares of America's eponymous steelmaker have lost 30% of their value. This downward trend almost seemed about to change when a relatively strong performance in Q2 resulted in U.S. Steel beating earnings on Tuesday -- sending the stock up 7% in response. But in the days since, U.S. Steel's stock rally short-circuited. As of today, the stock has given up all its post-earnings gains and now trades below what it cost pre-earnings.
Here are three things you need to know about that.
1. Wall Street bears part of the blame...
Part of the reason U.S. Steel stock is sagging owes to downgrades on Wall Street. This morning, analysts at Citigroup cut their rating on U.S. Steel stock from neutral to sell, and cut their price target to $20 a share -- 13% below where the shares trade today.
Citi worries that steel demand from the automotive industry and "tubular" (i.e., oil pipelines) will continue falling all through the end of this year. Although encouraged by U.S. Steel's recent report to raise its earnings estimate for this year, Citi sees major "downside" in 2018 and 2019 as well. Citi completely erased its expectation for $1.27 per share in profits in 2018, replacing its projection with a $0.01-per-share loss. The banker further cut expectations for U.S. Steel's 2019 earnings from $1.76 per share to just $0.33. And that's not the worst of it.
Citi's move follows a similar downgrade by Longbow Research yesterday. As StreetInsider.com (requires subscription) reports, Longbow analysts believe that despite U.S. Steel's "beat," certain "comments" from President Trump will limit "trading upside" on U.S. Steel stock going forward.
2. ...but President Trump bears more
What were those comments, exactly? As you probably recall, steel investors have been riding high on hopes that the U.S. government would impose tariffs and quotas to curb unfair pricing of steel imports. Earlier this year, Deutsche Bank made the expectation of such protectionist measures central to its upgrades of both U.S. Steel and AK Steel (NYSE:AKS). (Note: AK Steel was also downgraded by Longbow yesterday, despite AK, like U.S. Steel, having just beat on earnings.)
But in an interview with The Wall Street Journal on Tuesday, President Trump told reporters that he does not, in fact, want to impose tariffs and quotas on imported steel "at this moment." Objections from trade partners (who don't want their exports curbed), and from domestic steel users as well (who like the idea of cheap foreign steel) are sapping administration support for the trade protections.
Instead of imposing sanctions "very soon," as the steel industry was hoping, the president says his staff will need to do "statutory studies ... addressing the steel dumping" issue. And while the president promised action "fairly soon," he also said that the administration plans to address healthcare reform, tax reform, and may even want to get an infrastructure bill passed by Congress before returning to the steel issue.
All of which suggests steel tariffs won't be arriving "soon" at all.
3. How U.S. Steel is doing today
The question is whether U.S. Steel can survive that long. And maybe it can after all.
On Tuesday, U.S. Steel reported strong earnings of $1.48 per share, only $0.41 of which was attributed to the one-time proceeds from selling U.S. Steel Canada. This worked out to nearly a fourfold increase in per-share profits for U.S. Steel against last year's Q2. Commenting on the results, U.S. Steel CEO Dave Burritt observed that U.S. Steel saw "higher prices and volumes in all of our segments," in Q2, along with "improved results from our mining operations." European operations were "solid," and U.S. Steel's tubular operations -- while not yet profitable -- "continue to make progress" in that direction.
Management believes that if the steel market continues going as it is currently, the company could earn as much as $1.70 per share this year. And while management warns investors that the steel market probably will not continue going as it is currently, and could either improve or deteriorate, CEO Burritt is nonetheless "bullish" on the company's future.
What it means to investors
Should investors also be bullish on U.S. Steel? Here's how I see it:
Management says profit of $1.70 per share this year is at least possible, and at U.S. Steel's current share price, that would give the stock a P/E ratio of about 14. Problem is, most analysts who follow U.S. Steel stock predict U.S. Steel will only grow its earnings at about 8% annually over the next five years (according to S&P Global Market Intelligence). That's a PEG ratio of 1.75 -- which value investors would ordinarily consider pretty expensive.
On top of this, Citi says U.S. Steel could very likely earn only $1.18 this year -- nearly 31% below U.S. Steel's best-case scenario -- and that would give the stock a P/E of 20, and a sky-high PEG ratio of 2.5.
Given these scenarios, I'd say Citi (and Longbow) are right to downgrade U.S. Steel stock. Unless and until the U.S. president rides to its rescue, this stock simply costs too much for the profit it's likely to earn.