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U.S. Steel Stock Suffers a Double-Downgrade

By Rich Smith - Sep 19, 2019 at 2:27PM

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This quarter's earnings miss will be much worse than feared.

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...

Pity U.S. Steel (X 1.08%) investors. They just can't catch a break.

A little over a month ago, U.S. Steel reported its fiscal Q2 earnings, and from at least one perspective, the news didn't look all that bad. On the one hand, yes, earnings declined year over year -- and steeply. On the other hand, though, at least U.S. Steel didn't do quite as badly as analysts had forecast, beating on both sales and earnings for the quarter.

But don't get too used to that happening.

Molten steel pours in a foundry

Image source: Getty Images.

U.S. Steel warns

Last night after close of trading, U.S. Steel dropped a bombshell on its investors. Issuing new guidance for its fiscal third quarter 2019 currently underway, management warned: "The positive flat-rolled steel market indicators experienced earlier this summer have softened after a brief recovery in steel selling prices."  

"[M]arket conditions" in Europe, too, "have continued to deteriorate," with a "dislocation between steel selling prices and raw material costs" causing "significant margin compression." And scrap steel prices are down as well, with the effect that U.S. Steel can't sell new steel for as much as it would like.

Result: U.S. Steel is now forecasting that Q3's adjusted loss per share will be about $0.35 -- significantly worse than the $0.07-per-share loss that Wall Street had told investors to expect.

Investors, accordingly, are selling off U.S. Steel stock in droves, and the shares are down as much as 13% in early trading Thursday.

Adding insult to injury

As if all this wasn't bad enough already, Wall Street is piling onto U.S. Steel (in a bad way), cutting price targets and issuing downgrades. This morning, for example, StreetInsider.com reports that Credit Suisse has cut its price target on U.S. Steel by 11% to just $8 per share -- implying as much as 28% additional downside risk to the stock on top of the 13% decline it has already suffered today.

"Destocking and real demand weakness coupled with very high raw materials prices in Europe suggest earnings growth for X will be hard to come by over the medium term," the analyst says. Adding to investors' misery, Credit Suisse points out that U.S. Steel is continuing to spend on its $4 billion capital investment program, resulting in negative free cash flow at one of the biggest names in steelmaking globally.

Nor is Credit Suisse the only analyst feeling down on U.S. Steel today. Warning that "we expect steel prices to stay weak and the company's cash flow to be under pressure in a weak pricing environment," investment bank Macquarie is hitting the stock with the dreaded double-downgrade -- a reversal all the way from outperform to underperform (i.e., from buy to sell). Macquarie also cut its price target in half to $9 a share.  

Unless things improve quickly for the steelmaker, warns the analyst in a note covered on TheFly.com, U.S. Steel could suffer cash burn on the order of $1 billion (or worse) this year.

What it means to investors

In essence, this means that things could be getting really bad for U.S. Steel now -- and really fast. As I mentioned at the time of the company's last earnings report, U.S. Steel has already gone from a company generating modest levels of positive free cash flow ($321 million in 2017), to one only slightly in the red ($63 million in negative FCF in 2018), to one wading steadily deeper into a sea of red ink, with $262 million in cash burned in the first half of this year.

Now, Macquarie is warning us that unless things turn around in a hurry, the negativity of the company's free cash flow could double -- from burning cash at the rate of a half-billion dollars a year in the first half to burning a full $1 billion (or more) by year-end.

With U.S. Steel already deeply in the red, and lugging around a $2.3 billion long-term debt load (offset only partially by $651 million in cash, according to S&P Global Market Intelligence figures), this is not a good situation to be in -- and Macquarie is right to warn investors to get out now.

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