What Is The Deal With United States Steel Corporation?
United States Steel Corporation (NYSE: X) shares are on an unprecedented run since July 29. It has rallied from that day's closing price ($27.67) to more than a three-year closing price high on Thursday, September 18 ($46.00).
The latest surge in prices took place on September 17, when it rallied more than $5.00, from $41.41 to $46.61. The company announced it expected significant improvement in Q3 operating income and EPS to be significantly higher than previous estimates.
Not So Fast
Gordon Johnson of Axiom Capital is not so convinced the rally is for real, his interpretation of the supply-and-demand scenario being cited as the reason for the current euphoria that surrounds the issue.
"Axiom reported steel demand is up 5.6 percent year to date versus supply being up 11.2 percent," Benzinga's Garret Cook wrote on September 3. "The driver for this could be the excess inventory created as a response to supply scares in the first half of 2014."
Although Axiom has missed out on the recent rally, the company has reanalyzed the fundamentals to look "for a reason to become more constructive on the name - outside of the direction the stock is moving."
In other words, instead of price action dictating their stance, which is a common practice among Wall Street analysts, Axiom is searching for ways to justify the recent price action.
Here are the key points in Axiom's analysis:
"...when considering the inherent volatility in X's earnings to shifts in U.S. HRC spot prices, elevated by a prodigious resiliency in U.S. HRC spot prices (down -1.2% YTD), despite the fall in both iron ore (down -35.4% YTD) & coking coal prices (down -21.1% YTD), as well as the data points overwhelmingly suggestive of an inventory buffer build in response to the threat of limited steel availability."
The inventory buffer is not expected to be able to be sufficiently drained by increasing construction activity.
As for auto sales helping drive demand, which in turn would be expected to drain steel supplies, Axiom wrote "we infer to mean auto sales, as a component to steel demand, are actually on the decline when compared to prior year growth rates."
Interestingly, U.S. Steel indicates in its own recent report that it expects inventory to build in Q3. When overhead supply is above demand, this will not sustain higher prices going forward.
Consolidation In The Industry And The End Results
Another important factor leading to higher steel prices and the perceived higher demand has been the result of the recent consolidation in the industry. Not only in the United States, but also in China there has been a major consolidation among steel producers. This activity has created less players worldwide and has fostered a "pricing discipline" that has benefited the remaining players in the industry.
Similar consolidation periods in 1984, 2002, 2003 and 2008 yielded similar results in the short term but eventually led to a collapse in prices. A prime example of this reflected in share price was the rally in U.S. Steel shares from the low $90's in January 2008 to its all-time high in July at $196.00. Only eight months later in the wake of the financial crisis, it tumbled under $20.00 to $19.03.
It bottomed one month later at $16.66 and rebounded to $71.00 in April 2010. It revisited those lows and made a new one in June 2013 at $16.11 and went nowhere until later that year when it climbed above the then psychological $20.00 resistance level.
From that level, improved earnings and a rip-roaring bull market have taken the issue to the mid $40's. The question now is if the company's claims for higher demands will eventually be offset by the current inventory buildup.
Buy, Sell Or Hold
If so, the recent rally in its share could fade as quickly as it did in 2008. For those investors that have benefited from the recent doubling in its share price, it may be time to lock-in some profits. Other investors that have bought the shares recently in anticipation of continued gains, only time will tell if the rally in steel is for real.
U.S. Steel shares were trading lower by $1.53 (3.4 percent) at $43.65 at time of publication.
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