United States Steel's (X, Financial) stock has surged by a staggering 18% since the turn of the year as factors such as China's reopening and softer non-core inflation have provided its main commodity with significant support.
It is natural to wonder whether a stock might be overbought after such a significant near-term rally, especially because cyclical stocks such as U.S. Steel possess significant risk amid a weakening macroeconomic environment. However, after taking a closer look at U.S. Steel, I believe the stock's recent surge is warranted. Moreover, I think the stock remains undervalued; here's why.
Operational talking points
According to U.S. Steel's CEO David Burritt, 2023 will be the company's most transformational year ever as the goal is "to unlock the stockholder value of our Best for All strategy. In summary, we are bullish, we are confident, we are transitioning to greater stockholder value, we are focused on our competitive advantages, and we are delivering on our strategy."
U.S. Steel's fourth-quarter earnings report illustrated that the company is heading from strength to strength as it blitzed past its bottom-line estimates by 24 cents per share, consequently declaring a dividend worth five cents per share. The forward dividend yield is 0.67%.
Foundational to U.S. Steel's ongoing success are its low-cost iron ore and best-in-class finishing capabilities. These key products and services have allowed U.S. Steel to achieve economies of scale, visually represented by its superior operating margin of 14.74% (higher operating margins indicate potential moat characteristics).
On top of its ongoing operational prowess, the company has a cash position of approximately $3.5 billion, allowing it to sustain growth via capital expenditures while compensating its shareholders with dividends and incremental share repurchases.
There is no doubt that slower industrial production in 2022 and resilient input costs dampened U.S. Steel's full-year results. However, despite receding iron ore prices, U.S. Steel sustained its value-per-unit sales prices due to its illustrious market position. Moreover, I believe a macroeconomic inflection point has occurred which might allow U.S. Steel's income statement room to grow in 2023 and beyond.
Source: United States Steel
A long-term view suggests that the company is adding tremendous value by leveraging its mini-mill segment, which is projected to reach $1.3 billion in normalized Ebitda by 2026. Additionally, the company is making tremendous progress with its DR-grade pellet production to service the electric arc furnace market. Overall, it looks like U.S. Steel could benefit from ongoing strength in its core business while adding synergetic components to its operating model.
Macroeconomic support
Recent enhancements in social media mean that opinions are voiced easier and louder than ever before, and from my obervations, the most popular outlook on the economy is a bearish one, which is something for U.S. Steel's investors to consider. However, most opinions are backward-looking, so crowds don't typically keep up with the latest developments.
By looking at key data points, I believe it is evident that non-core inflation is tapering and that the United States' GDP growth should be higher than initially forecasted. Moreover, China's reopening has led to record manufacturing output, and Europe has abated an anticipated recession.
U.S. Steel's stock is cyclical, meaning it typically exhibits excess sensitivity to inflection points in the macroeconomic cycle. Thus, the stock could benefit from the recently improved macroeconomic outlook.
Source: GuruFocus (Logarithmic scale of U.S. inflation and GDP growth)
Valuation and dividends
The traditional way to value basic material stocks like U.S. Steel is by observing their price-book multiples, since basic materials are quoted and frequently traded on public exchanges.
At a price-book ratio of merely 0.66, U.S. Steel's stock looks undervalued relative to its fair equity book value. In addition, the stock's price-earnings ratio of 3.3 is better situated than 87.53% of the firm's industry peers, though it should be noted that cyclical stocks typically have the lowest price-earnings ratios at the peak of a cyclical upswing, so caution is needed here.
With a dividend yielding of merely 0.67%, U.S. Steel does not provide its investors with much income. However, the company has begun buying back shares after issuing a ton of new equity from 2020 through the first half of 2022.
Calls on Wall Street
The likes of Citigroup (C, Financial) and GLJ Research are bearish on U.S. Steel's prospects, as both parties believe the steel market might hit a snag in the coming quarters. Despite the bearish calls from sell-side analysts on Wall Street, it was revealed earlier this month that cutting-edge quantitative investment firm Trexquant Investments LP nearly doubled its stake in U.S. Steel. Texquant's data-driven investment approach uses a factual premise which takes the guesswork out of the equation. This objective investment approach provides substance to a bullish argument for U.S. Steel's stock from a quantitative standpoint.
Final word
Overall, I believe U.S. Steel's recent surge is justified by its robust organizational structure, which has allowed it to take advantage of an improved steel market. Although macroeconomic concerns loom, there are signs that more substantial industrial production might occur in 2023, lending the company's investors optimism. Furthermore, the stock looks fundamentally undervalued on several metrics, suggesting that market participants have yet to price in most of the company's recent success.
