The news flow out of United States Steel (X 1.51%) has been interesting of late, leading a Keybanc analyst to question management's motives.
That doesn't sound like a good thing. Since you're giving your hard-earned savings to a company's management team when you buy a stock, investors in U.S. Steel need to carefully consider recent events at the company.
The breakdown
The domestic steel industry has been softening of late. So it wasn't much of a surprise when U.S. Steel announced on Sept. 18 that results would be relatively weak in the third quarter. In fact, some of its peers, like Nucor (NUE -0.79%), made similar pre-announcements.
The steel industry is highly cyclical and there are signs of a global slowdown, so these pre-announcements, while unfortunate, are par for the course.
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Then, on Oct. 1, U.S. Steel announced that it was buying a 49.9% interest in competitor Big River Steel. It has the option to buy the rest of the company over the next four years. This move will help accelerate U.S. Steel's plan to diversify its production methods, increasing the amount of steel it makes using electric arc furnaces.
That's good for the company; it should help smooth out earnings. The blast furnaces that underpin its business today need to operate at high utilization rates to turn a profit, while electric arc mills tend to be smaller and more flexible. That often lets them run profitably during industry downturns.
Essentially, U.S. Steel is trying to be more like industry bellwether Nucor and Steel Dynamics (STLD -1.32%), which both use electric arc mills and have had more consistent financial results. The cost of this deal, which has yet to be consummated, is expected to be $700 million in cash.
A few days later, on Oct. 10, U.S. Steel released "preliminary unaudited" financial results for the third quarter. The numbers showed an improvement over the earlier pre-announcement, with the new release calling for adjusted EBITDA to be as much as 25% higher than the previous guidance.
And, finally, on Oct. 16, the steel maker sold $300 million in convertible bonds with a 5% coupon. Another $50 million may be added to that total if the original buyers of the notes wish to buy more. The cash will be used to help pay for the Big River acquisition.
The sequence matters
The order of events here is very important. The first earnings pre-announcement helped put downward pressure on the company's shares. That's understandable. The acquisition news was met with excitement, but market watchers started to wonder how U.S. Steel would pay for the deal. When a bond rating agency came out and suggested the cost might lead to a credit downgrade, the stock moved lower. No surprise. And then the stock moved higher when management provided the second earnings pre-announcement.
This was when Phil Gibbs, an analyst at Keybanc Capital Markets, explained to Bloomberg that "You have to question the motive when a company pre-releases twice." He added, "Why couldn't you wait three weeks to say this? Because you're desperate for good news. Why would you be desperate for good news? You'd be desperate for good news because you need money, and why do you need money, because you just announced a $700 million acquisition in the last week and a half."
Basically, Gibbs is suggesting that U.S. Steel made the second announcement so it could more easily raise money in the capital markets. It's hard to argue with the desired end here, noting that six days after Gibbs' comments the company did, in fact, sell $300 million worth of convertible debt. However, as an investor, you might want to think carefully about the means used by U.S. Steel.
Trust is a vital component in investing. When a company does something that makes you question that trust, even for the good of the company, you should pause. It's time to reevaluate your opinion of the management team you're trusting with your capital. On deeper inspection, you may think nothing of the choices made. Or you might, like Gibbs, question management's motives. If that's the case, you should ask yourself if you want to continue trusting the company's management with your money.
A big-picture thing
U.S. Steel isn't the only company that has left investors scratching their heads like this. But it once again highlights that there are larger, overarching issues you need to consider. Investing in stocks isn't easy. It requires time, effort, and a huge amount of thought, because profitable investing often means going against human nature. Part of that is being willing to stick with an investment through the good and bad times to see the long-term benefits of investing. Staying true to a chosen investment course is a key reason that Warren Buffett is so successful.
However, it's notable that Buffet has specifically highlighted the importance of trust in his investment approach at Berkshire Hathaway. That's what allows him to stick out the bad times. If you don't trust a company's leaders, you aren't likely to stick it out when times get tough. No one can make the final trust call for you with U.S. Steel, but it's definitely something you should be thinking about today. There are other steel mills you could own.
