Not to be outdone by fellow steelmakers Nucor (NYSE:NUE), AK Steel (NYSE:AKS), and International Steel Group (NYSE:ISG), all of which have reported nice, fat profits over the past few days, U.S. Steel (NYSE:X) clanged in yesterday with an announcement of "record net income." Revenues for the company's third quarter totaled $3.7 billion (a 48% increase over Q3 2003). And profits flowed in abundance: In contrast to last year's loss of $3.47 per diluted share, this year the company reported $2.72 per share in profits. Change is good.

Similarly on the cash flow front. In the first nine months of 2003, U.S. Steel generated positive free cash flow of $127 million; this year, that number quintupled to $648 million. That's actually a slightly better number than the corresponding generally accepted accounting principles profits figure for these first nine months ($610 million), suggesting a very high quality of earnings for the company.

Now, let's project out a bit and see how U.S. Steel should fare for the year 2004 as a whole. Cash from operations is moving toward a run rate of a little more than $1.35 billion for the year. And the company projected total capital expenditures for 2004 of $570 million (a significant increase over the run rate, which was looking closer to $490 million). Subtract the latter from the former, and we are probably looking at about $780 million in free cash flow for the year. Good, but not as good as we would have expected absent the capital expenditures projection, so thanks are owed to management for that bit of extra information. On the other hand, if these projections prove even close to accurate, the company's free cash flow for the year will wind up being about twice its trailing numbers as shown on Yahoo! (NASDAQ:YHOO) Finance.

To put all this together and get a handle on U.S. Steel's valuation, we'll first need an updated enterprise value. Net out its latest long-term debt figure of $1.57 billion and cash hoard of $1.06 billion, and the enterprise value becomes $4.76 billion. Divide that by the $780 million in free cash flow and voila! U.S. Steel's enterprise value-to-free cash flow ratio is 6.1 (about the same as its forward P/E). Balance that against the company's projected five-year earnings growth rate of 8%, and the company does indeed appear to be undervalued.

Just don't forget the old investing maxim about not buying cyclicals when their P/Es are low.

For more Folly on cyclicality and why steel is (but won't always be) profitable, read:

Fool contributor Rich Smith has no interest in any of the companies mentioned in this article.