After rising almost 120% from its March lows of this year, at the current price of almost $11, US Steel Corp stock (NYSE: X) looks highly overvalued. US Steel stock rallied from $5 to $11 off its recent bottom, compared to the S&P 500 which increased 60% from its recent lows. The stock has been able to beat the broader market in the last 8 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. Despite the stock still being almost 70% below its 2017 level, it is likely to drop as sharply as 45% in the near term. Our dashboard What Factors Drove -69% Change In US Steel Stock Between 2017 And Now? provides the key numbers behind our thinking.
Some of the stock price decline between 2017-2019 is justified by the 70% decline in the P/S multiple. This is despite a cumulative rise of 5.6% in revenues between 2017 and 2019, which in turn saw an 8.8% rise in revenue per share (RPS) during this period as the number of shares outstanding declined marginally. 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.
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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 in 2020 before recovering over recent months and currently stands at 0.14x. 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 is likely to drop close to 0.10x from the current level which points toward a drop in the stock price in the near term.
The global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. Lower steel demand from construction and automobile players, led to a drop in global steel prices recently, which had already declined due to the ongoing US-China trade war. This is reflected in the company’s Q2 and Q3 2020 results. US Steel’s revenue dropped by 41% (y-o-y) to $2.1 billion in Q2 2020. In Q3 2020, revenues decreased 24% y-o-y. This was due to significantly lower shipments in the flat-rolled and tubular divisions, along with lower price realization.
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. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. The US raw steel capacity utilization for the week ending 7th November 2020 was 71%, which is lower than 79% 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 over recent months mainly due to broader sector and economic developments, we believe that the stock has far 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, significantly lower than its current price of close to $11.
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