Strength Test: Could U.S. Steel's 1Q16 Earnings Justify Its Rally?
2016 guidance
As noted in the previous part of this series, U.S. Steel Corporation (X) fell steeply after its 4Q15 earnings release, despite beating the consensus earnings estimate by a wide margin. The sharp negative price action was due to the 2016 guidance provided by U.S. Steel’s management. During its 4Q15 earnings call, U.S. Steel said that assuming “current market conditions which include spot prices, import volumes, and supply chain inventory levels,” the company would barely break even at the EBITDA ( earnings before interest, tax, depreciation, and amortization ) level in 2016. Furthermore, U.S. Steel said that the company would burn $200 million in cash this year, despite reducing working capital by $500 million and cutting the capital expenditure.
Current status
Note that while Nucor (NUE) and Steel Dynamics (STLD) provide quarterly earnings guidance, U.S. Steel and ArcelorMittal (MT) give out annual EBITDA guidance. Last year, both U.S. Steel and ArcelorMittal cut their EBITDA guidance during the year. Lower EBITDA guidance was not received well by the markets and both companies saw negative price action after they reduced their EBITDA guidance.
Markets have improved
This year, both these companies gave their annual EBITDA guidance based on the market situations prevailing in January. However, steel market conditions have improved since January. We could see both U.S. Steel and ArcelorMittal raising their 2016 guidance during their respective 1Q16 earnings calls.
Having said that, markets have already started to factor in the improved steel market conditions. According to consensus estimates, U.S. Steel is expected to post EBITDA of $211 million in fiscal 2016 and $562 million in fiscal 2017, as can be seen in the graph above. In a nutshell, U.S. Steel would need a reasonably higher guidance to justify above-average valuation multiples.
Investors looking to diversify the risk of investing in a single security could consider the SPDR S&P Global Natural Resources ETF (GNR). Almost a quarter of GNR’s holdings are invested in steel and other metal companies. In the next part of this series, we’ll explore how U.S. Steel’s 2016 guidance might impact its valuation multiples.
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