US Steel stock (NYSE: X) has rallied 60% since late March (vs. about 56% for the S&P 500) to its current level of close to $8. This is after falling to a low of $5 in late March, as a rapid increase in the number of Covid-19 cases spooked investors, and resulted in heightened fears of an imminent global economic downturn. The stock was able to beat the broader market in the last 4 months as steel prices are expected to rise in the near term with the US government announcing a string of measures along with stimulus packages announced in other economies to keep businesses afloat. In addition, with the Chinese economy opening up, this led to expectations of a rise in steel demand and reduction of supply constraints. The stock is currently about 15% below its February 2020 high.
Despite the sharp rise in the last few months the stock is still 77% below the levels seen at the end of 2017. Does that mean that the stock is bound to go up from here? It is unlikely. In fact, we believe that the stock has surpassed its near-term potential and could see a decline of around 20% from its current level in the near term. Our dashboard What Factors Drove -77% Change In US Steel Stock Between 2017 And Now? provides the key numbers behind our thinking.
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Some of the stock price decline between 2017-2019 is justified by the 79% decline in the P/S multiple. This is despite a cumulative rise of 5.6% in revenues between 2017 and 2019, which in turn led to an 8.8% rise in revenue per share (RPS) during this period as the number of shares outstanding saw a marginal decline. However, despite this rise in RPS, the P/S multiple declined sharply as the stock price saw a continuous drop since 2017. Global steel prices declined due to the US-China trade war, while the price of the primary raw material (iron ore) remained elevated, which led to the company reporting losses in 2019. Thus, the revenue decline (in 2019) along with losses, led to a decline in the stock price, in turn affecting its valuation multiple.
The P/S multiple declined from 0.50x at the end of 2017 to 0.15x at the end of 2019. The multiple dropped even further and currently stands at 0.10x. The drop in the P/S multiple in 2020 was led by a further drop in steel prices following the outbreak of coronavirus. However, we believe that the company’s P/S multiple could remain around the current level, which coupled with lower revenues, could lead to a drop in the stock price in the near term.
What’s the trigger for downside?
The global spread of coronavirus has led to lockdown in various cities across the globe, which has affected industrial and economic activity. Lower steel demand from construction and automobile players, has led to a drop in global steel prices recently, which had already seen a drop due to the ongoing US-China trade war. This is reflected to a certain extent in the company’s Q1 and Q2 2020 results. US Steel’s revenue dropped by 41% (y-o-y) to $2.1 billion in Q2 2020. The US flat-rolled steel shipments declined by 36% to 1.79 million net tons while steel shipments from U.S. Steel Europe plunged by 39% to 610,000 net tons. Tubular steel shipments decreased by 32% to 132,000 net tons. The average realized price of flat-rolled fell by 7.5% to $721 per net ton while that of U.S. Steel Europe declined by 3.1% to $632 per net ton. The tubular average realized price dropped by 15.5% to $1,288 per net ton.
US Steel’s stock recovered recently on expectations of a rise in global steel prices as major economies started lifting lockdowns gradually, which could likely lead to increased demand and lower supply bottlenecks. The US raw steel capacity utilization for the week ending 22nd August 2020 was 63%, which is significantly lower than 80.1% recorded in the prior year period. However, this is an improvement over the 51% utilization in the beginning of May 2020, which indicates that there are signs of a rebound in activity in the steel sector.
However, company-specific operational challenges remain. Even if the steel market recovers sometime soon, we do not believe that US Steel would be able to benefit as much from this recovery as its peers, like ArcelorMittal. Even during such a difficult crisis, US Steel is burning a lot more cash than its peers, especially with its $2-billion flat-rolled segment asset revitalization program, US Steel’s free cash flow decreased drastically from about $450 million in 2016 to -$470 in 2019, reflecting a net cash outflow. At the same time, the company’s cash balance halved from $1.5 billion to $750 million.
Though the stock rebounded due to broader sector and economic developments, we believe that the stock has breached its near-term potential. As per US Steel valuation by Trefis, we have a fair price estimate of $6 per share for US Steel’s stock, lower than its current price of close to $8.
For further insight in the steel sector, see how ArcelorMittal compares with US Steel.
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