Yahoo Finance Could United States Steel Corporation Be a Millionaire Maker Stock?
United States Steel Corporation (NYSE: X) is a storied name in the steel industry. And its stock is still over 80% off of the highs it reached before a deep industry downturn hit following the painful 2007-2009 recession. It looks like there's a massive amount of recovery potential here that could easily make someone a millionaire. But I don't recommend jumping at this opportunity unless you can handle a great deal of uncertainty and risk. Here's what you need to know.
Disadvantaged production
The first issue to understand about U.S. Steel is that it relies heavily on blast furnaces to produce primary steel. Blast furnaces are a vital source of steel and aren't going away, but they are less flexible and can be more expensive to operate compared to more modern electric arc mini-mills. Nucor Corp (NYSE: NUE) and Steel Dynamics are two companies that are focused on electric arc technology. To simplify the issue, blast furnaces need to run at high capacity rates to be profitable, while it's easier to adjust mini-mills to current market conditions.
Image source: Getty Images
This is no small matter. U.S. Steel bled red ink in seven of the ten years from 2007 to 2016. Earnings at AK Steel, which also relies heavily on blast furnaces, were negative in eight of those years. For comparison, Nucor was in the black in nine of the past 10 years, with Steel Dynamics posting positive earnings in eight of those years. The steel industry is starting to see improving fundamentals, helping to push U.S. Steel back into the black in 2017, but that long stretch of red ink highlights a key fundamental risk embedded in the company's heavy reliance on blast furnaces.
Financial strength
The losses at U.S. Steel have translated to other problems as well. For example, debt makes up around 45% of the steel company's financial structure. While not an unreasonable level, it is notable for a cyclical industry that's prone to volatile ups and downs.
That number, however, is after the company started to focus on debt reduction. Long-term debt levels went up between 2007 and 2012, with debt peaking at around 50% of the capital structure.
X Total Long Term Debt (Quarterly) data by YCharts
Long-term debt only makes up around 30% of the capital structure at Nucor, a far more conservative total. But there's a second order effect here. All through the downturn Nucor was investing in its business by building new facilities, expanding existing assets, and opportunistically buying competitors. It was getting stronger through the downturn. In the first quarter of 2017 U.S. Steel announced that it was going to start ramping up capital investments during the developing upturn. Investors took that to mean it hadn't invested enough in the downturn, and that U.S. Steel would be playing catch up to competitors like Nucor. The stock sold off sharply, and the CEO retired shortly after the earnings announcement.
The takeaway here is that U.S. Steel's relatively inflexible business and bottom-line losses were compounded by a heavy debt load. That left it in a situation where it had to play defense. Nucor's lower leverage, flexible mills, and ability to turn a profit in a difficult industry environment meant it could build for the future.
Not worth the risk
When steel prices and demand are high, U.S. Steel can run its mills at high utilization rates and make robust profits. With a stock price that's still well off recent peaks, that suggests there's notable recovery potential in the shares -- but only if demand and pricing continue to improve. There's no way to predict if that will happen. U.S. Steel could make a millionaire out of aggressive investors if just about everything swings in the company's favor, but most investors would be better off focusing on better-positioned steelmakers if they are looking at this industry today.
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Reuben Gregg Brewer owns shares of Nucor. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.
