U.S. Steel: Staying Positive (NYSE:X)

United States Steel Corporation (NYSE:X) is in the news again after President Joe Biden stated the firm would remain “American owned,” promising that a foreign sale will not be allowed for as long as he’s in power.

We covered U.S. Steel a few months ago, before the Nippon (OTCPK:NPSCY) merger agreement. Our analysis forecasted a bidding war, which ended up happening, causing United States Steel’s stock to tick up by nearly 10% ever since.

Considering the abundance of recent developments, much time has passed since our latest coverage of United States Steel. Thus, we decided to revise U.S. Steel’s prospects with emphasis placed on President Biden’s recent comments.

Herewith are our latest findings.

President Biden’s U.S. Steel Comments

U.S. Steel’s shareholders recently approved Nippon’s $14.9 billion offer to acquire the firm (Nippon is a Japanese steelmaker). As a result, Biden made a staggering statement earlier this week, claiming that he won’t allow U.S. Steel to become a non-U.S.-owned company.

The president’s statement was centered on U.S. Steel’s historical significance and its alliance with society. However, the question now becomes: How realistic is the president’s promise, and how will it affect U.S. Steel’s stock price?

Firstly, I want to begin by saying that none of us are legal experts. However, we know a thing or two about acquisitions and politics.

With that, I’d like to address the first area of concern, which is political gamesmanship. Keep in mind that the U.S. general election is around the corner. Ascertaining the working class vote is highly profitable to political parties as it spans a significant amount of the voter base. We aren’t necessarily accusing the Biden administration of playing politics in an election year. Still, we do flag the possibility of the U.S. Steel comments being a political narrative rather than a tangible attempt to “save” the firm from foreign ownership.

Furthermore, the regulation of M&A in the United States should be considered. Although they’re organs of the federal government, the Department of Justice’s antitrust division, the Federal Trade Commission, and the SEC usually oversee breaches of M&A law, anti-competitive matters, and securities laws.

Let’s say we’re wrong, and Biden’s administration blocks the deal. What’s the worst that can happen?

Nippon already offered $55 per share, which is much higher than U.S. Steel’s current market price of around $40. A lower premium-to-acquire will likely occur if foreign bids are blocked. However, we don’t think the premium will diminish altogether. In fact, there’s a very small probability of a profitable company like U.S. Steel being sold at or below its market value.

In conclusion, we think President Biden’s comments will add turbulence to U.S. Steel’s stock, but we think a premium-to-market price deal will occur, regardless of the outcome.

Now, Let’s Look At The Nippon Deal In Isolation

As mentioned before, Nippon agreed to a $14.9 billion deal with U.S. Steel’s board and shareholders, which represents $55 per share. At the time of writing this article, the offer presented a premium of around 37.5%, illustrating the robust demand for a U.S. Steel takeover.

Merger arbitrage theory states that a failed acquisition would bring a company’s stock price back to its pre-agreement level. U.S. Steel was subject to a bidding war before the Nippon agreement, meaning its pre-acquisition price isn’t confined to the Nippon offer. Based on our previous article and past memory, we record U.S. Steel’s pre-bidding war price as being nearer to $30 per share.

Realistically speaking, we won’t see U.S. Steel’s stock retracing to its pre-bidding war level unless it decides against a sale, which also is unlikely given that 98% of its voting shareholders agreed to a Nippon sale. Although we think non-foreign bidding will lead to a lower premium, we anticipate local demand being high enough to sustain a premium above U.S. Steel’s current market price.

Lastly, U.S. Steel’s stock has a price-to-book ratio of merely 0.8x, a price-to-sales ratio of 0.55x, and a forward price-to-earnings ratio of 10.44x, suggesting it’s undervalued regardless of its acquisition activity, especially considering that it’s a profitable company.

U.S. Steel’s Internal Developments

I’m not going to spend too much time here, but I thought it would be prudent to outline a few of U.S. Steel’s internal developments.

U.S. Steel’s fourth quarter earnings report landed in February, revealing a revenue beat worth $580 million and an earnings per share beat of 40 cents. The company’s latest earnings beat forms part of a string of EPS beats, indicating earnings momentum. Sure, higher prices have helped, but keep in mind that U.S. Steel faced significant input costs during this period.

As visible in the following diagram, U.S. Steel’s success likely stemmed from higher shipping and product prices in its tubular segment. Some segments, such as EU Steel and Mini Mill, suffered from price pressure, but we don’t see anything structural in this, attributing it to an industry-wide trend.

Furthermore, flat-rolled product shipments stagnated, which isn’t surprising given the doubtful machinery and housing frame environments faced during 2023’s elevated interest rate landscape.

We remain coy about the demand side of U.S. Steel’s business as elevated interest rates, economic uncertainty, and the industrial cycle dictate caution. However, salient data does present some optimism. For example, the U.S.’s March inflation settled at 3.5%, illustrating resilient consumer demand. However, producer prices are incrementally lowering, providing margin expansion prospects to companies like U.S. Steel.

Furthermore, we remain optimistic about U.S. Steel’s mini-mill business. The firm’s existing mini-mill business and its mini-mill capex roadmap include plans to leverage cutting-edge technology and widen profit margins. Although U.S. Steel will likely be sold soon, interim idiosyncratic competitive advantages don’t hurt shareholders’ prospects.

A Few Contra Points

Even though we remain bullish about U.S. Steel’s prospects, a few headwinds exist.

Firstly, ongoing M&A uncertainty could drag the stock downward as many of its shareholders will grow impatient. Moreover, the ongoing back-and-forth introduces additional volatility, leading to divestment from many of U.S. Steel’s risk-off investors. In essence, a speculative environment might occur, altering the nature of U.S. Steel’s investor base.

Furthermore, a look outside M&A is warranted. A lot of economic uncertainty exists, which could relay into steel stocks. In fact, U.S. industrial demand has yet to recover to the heights experienced in late 2022.

Lastly, U.S. Steel stock faces technical concerns. The stock has dipped below its 10-, 50-, and 100-day moving averages, suggesting a downward trend has emerged. Moreover, U.S. Steel has a Put/Call Ratio of 1.93, indicating that investors are hedging their bets in the options market.

Final Word

Our latest analysis of U.S. Steel tells us that its stock price is likely dominated by exogenous events such as its pending takeover and political opinion surrounding the phenomenon. However, we remain positive about the stock’s prospects given the robust demand for a U.S. Steel takeover. Moreover, we think the stock is undervalued on a standalone basis.

Although risks such as technical stock pricing headwinds and economic demand-side uncertainty exist, we maintain our Buy rating.

Consensus: Buy/Market Outperform