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Analyst Blasts U.S. Steel Stock With Sell Rating: 3 Things You Need to Know

By Rich Smith - Apr 8, 2016 at 11:30AM

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Here's one thing: U.S. Steel isn't the only steel stock that UBS hates.

Friday is turning out to be a rather black day for investors in U.S. Steel (X 4.30%). The stock is down 35% over the past 52 weeks, but according to analysts at UBS, it has another 25% to fall.

The news
Putting its mouth where its money is, UBS announced this morning that it's downgrading U.S. Steel stock to sell on the theory that the stock -- currently trading at $16 and change -- will soon fall to $12 a share. And the reason for this theory is not what you think. It has little to do with the fact that U.S. Steel has a history of reporting GAAP losses (five money-losing years out of the past six). It has everything to do with the fact that UBS worries U.S. Steel will never generate real cash profits -- and may in fact be doomed.

Do we have your attention now? Here are three things you need to know about the new rating.

U.S. Steel is a giant of industry. But the bigger they are... Image source: U.S. Steel.

Thing No. 1: Cash is king (and U.S. Steel isn't making any)
As related by this morning, UBS starts off its re-rating of U.S. Steel stock with a few kind words about how the company's "cost cutting and working capital reductions have helped to improve X's cash flow position." But that's where the compliments end.

Very quickly, UBS segues into a discussion of how "these improvements must ultimately diminish" as US Steel runs out of cut-able costs, leaving U.S. Steel "in a long-term cash burn position."

Thing No. 2: Why so glum, chum?
Why is UBS so convinced that things look so dire for U.S. Steel? One imagines that part of the reason is that based on its most recent financial reports, as related on S&P Global Market Intelligence, U.S. Steel is in fact burning cash -- and indeed, that it generated negative free cash flow in four of the past six years.

Currently, hot rolled coil steel sells for just $480 per ton. Forecasters believe it will inch above the $500 mark next month, but stay very close to $500 for at least the next two years. That's a problem for U.S. Steel, says UBS, because "given the company's history of burning cash as long as HRC prices are below $500/t, we would anticipate X to be generating negligible free cash flow under our steel price forecast." 

Thing No. 3: Cash is king (but debt is emperor)
With no cash coming in, and only the prospect of "negligible free cash flow" in years ahead, UBS has serious doubts about how U.S. Steel will be able to manage its "$2.4 billion net debt" load "should weak market conditions persist in the medium-term."

Translation: While UBS hopes that US Steel "has sufficient liquidity to withstand the low steel price and utilization environment in the US over the near-term," longer term, there's a very real risk of bankruptcy.

And one more thing
Now before you get to thinking UBS is piling on US Steel, a stock that has been very publicly losing to the market for some time now, you should know that UBS also panned U.S. Steel rival AK Steel (NYSE: AKS) today -- and for much the same reasons.

Marking down AK Steel stock to "sell" as well, UBS decried AK's "$1.6 billion of debt maturing" over the next five years, its "relatively high cost base and a track record of sustained ongoing cash burn."

Granted, currently AK Steel's situation is a bit better than U.S. Steel's, and the company is currently free cash flow-positive (with about $101 million in cash profits generated last year, according to S&P Global). UBS also credits AK with being able to produce at least "very modest free cash flow going forward." Nonetheless, if steel prices don't improve, and soon, UBS sees AK Steel ultimately following the same path as U.S. Steel -- and rates it a sell as well.

With AK Steel now selling for an enterprise value-to-free-cash-flow ratio of 30:1, and growth projected at no more than 4% annually over the next five years, I'm inclined to agree.

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