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United States Steel Corporation: Buy the Dip?

By Neha Chamaria – Aug 16, 2018 at 3:45AM

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The steel manufacturer is boosting productivity and deleveraging, and its stock is the cheapest among peers.

Founded in 1901, United States Steel (X 3.81%) is one of the oldest American companies. Yet, even with more than a century's experience in steelmaking, U.S. Steel is hugely lagging Nucor (NUE 2.86%) in terms of sales. Nucor and Steel Dynamics (STLD 3.14%) have also consistently churned out greater profits from sales than U.S. Steel. While Nucor was founded in 1940, Steel Dynamics started operations only in 1993.

U.S. Steel, however, is striving hard to turn things around through a series of initiatives. Its second-quarter numbers also handily beat analysts' estimates recently. The stock, however, has dropped almost 17% in just the past one month. Should investors consider this dip in U. S. Steel an opportunity?

One reason U.S. Steel couldn't keep up with rivals

A major reason why Nucor and Steel Dynamics could race past U.S. Steel over the years is their business model. U.S. Steel manufactures steel using traditional blast furnaces. It's a time-consuming, complex, capital- and labor-intensive process with limited flexibility. Nucor, on the other hand, experimented with electric "mini-mills" decades ago and succeeded. Steel Dynamics emulated the idea.

A closeup of steel pipes.

Image source: Getty Images.

While mini-mills are smaller in size and can't produce all kinds of steel products, the pros easily outweigh the cons. To list a few, mini-mills use scrap -- typically from automobile and machinery junkyards -- to manufacture steel, which lowers raw material costs substantially. The smaller size and scale also mean low labor and capital requirements, and greater flexibility in adjusting production which proves particularly handy during weak business conditions.

Mini-mills and the flexibility that comes with them, therefore, can take much of the credit for Nucor's and Steel Dynamics' growth over the years.

X Revenue (Annual) Chart

X Revenue (Annual). Data source: YCharts.

Even as U.S. Steel struggled to make money especially through downturns, ill-timed moves such as its acquisition of Canadian steel manufacturer Steelco at the peak of the business cycle proved even more costly. U.S. Steel's debt burden got heavier even as its sales growth decelerated. The company's debt is still among the highest in the industry, and operating profits among the lowest.

X Total Long Term Debt (Annual) Chart

X Total Long Term Debt (Annual). Data source: YCharts.

U.S. Steel's debt maturity profile, however, has improved considerably over the past couple of years, and the company is confident its ongoing $2 billion "asset revitalization program" will lead to stronger and leaner operations by 2020.

A lot is happening at U.S. Steel right now

U.S. Steel recently delivered encouraging numbers for its second quarter. Key highlights from the quarter include:

  • 15% growth in year-over-year revenue, driven by firm steel prices and shipments.
  • 20% growth in adjusted EBITDA (earnings before interest, income taxes, depreciation and amortization).
  • 18% drop in net income.
  • 39% growth in adjusted net income.

Adjusted EBITDA and earnings broadly exclude non-operating costs, gains, and losses such as those related to restructuring, facility idling or restarts, and sale of interests in equity investees. U.S. Steel uses this non-GAAP metric to provide outlook: It raised its full-year adjusted EBITDA guidance to $1.85 billion-$1.9 billion from $1.7 billion-$1.8 billion.

The market, however, is mostly short-sighted and can't seem to get over the fact that U.S. Steel expects a weak third quarter because of a planned outage at its Great Lakes Works facility.

The outage is, in fact, part of U.S. Steel's flat-rolled segment asset revitalization program that aims to improve productivity and reduce costs in the long run. The company has outlined $2 billion for the program, with $1.5 billion for capital spending and $500 million for expenses. Into its second year now, the program is expected to be complete by 2020 and add $275 million-$375 million annually to U.S. Steel's EBITDA.

Graph showing how U.S. Steel's debt profile has changed between 2016 and now.

Image source: United States Steel.

Meanwhile, U.S. Steel has pared down or restructured a good portion of debt, so much so that the company now has debt worth $480 million due for maturity between 2018 and 2022. That figure was a whopping $2.3 billion in 2016.

So is the stock a buy?

With a market capitalization of $5.4 billion and net debt of $1.3 billion, U.S. Steel has an enterprise value of $6.7 billion. Factoring in the company's EBITDA of $1.2 billion in the trailing 12 months, the stock is trading at an EV/EBITDA of only 5.6 times. That's cheaper than Nucor, Steel Dynamics, and even AK Steel, which isn't in the best shape right now.

U.S. Steel looks compelling from that standpoint, but you need to have patience with this stock as any upside may not come easy, one reason being that tariffs imposed by the Trump administration are hugely boosting steel prices for now. Any reversal could pressure steel prices and the company's sales, muting its growth prospects.

Neha Chamaria has no position in any of the stocks mentioned. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.

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