Monday, October 27, 2008
(Cont'd from above)...

We know that, other than UBS, pretty much everybody on the Street is predicting numbers that are way too high for next year... and analysts don't like to slash earnings estimates, and still keep a stock as a buy... It's considered to be bad etiquette... so these five "buys" could very easily become "holds" or "sells"... And that means that, even though X has already fallen from $196, to $30 bucks, in just five months, amazingly, I could see letter X going even lower, on a wave of analyst downgrades. Although you have to wonder... where were these analysts 160 points ago? Were they "sis-boom-bah'ing" the darn thing?... Yes. We could see a race to cut numbers and downgrade... to go below the UBS number, to establish the low number... which is what people do... and some ultimately will I believe... to predict a loss for next year. That's the way the analysts play it. Next thing you know, you've got a story where a stock that was supposed to earn $15 a share, last Friday... that was the estimate... look cheap... look cheap all week, and then it goes to break even. And that cheap-looking stock that trades at 2x earnings... or closer to 1x earnings if you use some of the higher estimates... Merrill's thinking X is going to earn $22 a share next year... Well, all of the sudden, a company that you thought was going to make $22 a share, and is selling at $30, looks real expensive, when you cut that number...

All of this can happen very quickly when you're dealing with a company like X, that has very high fixed costs... which means that end-market pricing... what they sell the steel for... can come down much more quickly than what it costs them to make the steel. That's the time-honored problem with giant steel mills. X's end markets are looking real ugly... The company sells about half of the domestic flat-rolled steel, a segment that makes up about 58% of the company's sales, under annual contracts with oils... oh my... is there like, one auto company yet?... Wake me when that happens... And appliance companies... No one's bought an appliance in this country in 9 months... alright, maybe a couple... Two sectors... appliances and autos... are having serious financial troubles... to understate the situation. X is also largest domestic producer of tubular products used in pipe for drilling for oil and natural gas, another business that should drop off, because oil and natural gas prices have just plummetted. Driller capital expenditure cuts are going to hit U.S. Steel hard... especially with onshore natural gas drilling... that's 70% of X's tubular sales... We know those are going bad... I mean, we know those are going bad big time... anybody who was listening to the Nabors (NBR) call knows that... Global markets are deteriorating too, with European manufacturers reporting difficult market conditions and excess inventory...

That is the kiss of death...

Here's the big problem... As these end markets fall off, and as X... with 24% of its sales coming from Europe... gets hurt by a strong dollar, it will then... look, steel prices go down, and X's costs are largely fixed. It mines its own iron ore, and only partially uses scrap, which puts it on a terrible footing, compared to its mini-mill competitors that use much cheaper scrap steel in their production... albeit better footing than these steel companies that paid top dollar for ore just a few months ago... including Chinese communist scrap mills...

Scrap prices have fallen from $900 a ton in July, to less than $250 a ton now... Holy cow!... So, as conditions in the steel market get tighter... meaning, get worse... these mini mills can produce steel at a cost of $400 to $450 a ton... That is so much lower than X's fixed production costs. X prices came in at $680 a ton in the second quarter. They'd have to cut prices by 35-40%, just to stay competitive with mini mills that rely on scrap.

Hey, it gets worse...

One of the reports today said that X's pension plan is expected to be underfunded by $2.6 billion at the end of the end of the year, compared to being fulling funded by $223 million at the end of 2007... If funding levels fall below 75%, that could trigger the Pension Protection Act of 2006, which will require X to make contributions toward its pension. That would just further erode the earnings...

Given all these factors, I could easily see X going even lower, off of a wave of estimate cuts. It has happened before in this industry. In the '80s, Bethlehem Steel went from 1x earnings, to making huge losses in about a year's time, and it was a sell all the way down, and ultimtely declared bankruptcy... It happens in this industry. I owned Bethlehem Steel back in the '80s...

The one solace... is U.S. Steel's dividend. Right now, it yields 3.5% but, with over $3 billion in debt, and next year's earnings very much in danger, we can't even be completely sure the dividend is safe, as much as we believe that they will stick with it as much as they can, and we think John Sirna (CEO) is great...

Where would X be cheap?...

If it gets to $22 bucks, then it would be cheap. But, if it gets to $22 bucks, Nucor (NUE), which is one of the scrap producers... Dan DiMicco... remember, we had him on last week... with lower costs and a bigger dividend, will be the better buy... The bottom will be put in when we get more estimate cuts, and everyone goes to a sell, and the most prescient analysts... the bottom line analysts... the Bank of America guys who have been calling X a sell since August... recommends the stock.

The bottom line...


The bottom line!:     Remember, tradition, P/E multiples are out... P/E multiple analysis doesn't work when a recession hits... and we know from Donald Trump... it's not a recession... the Donald says it's a depression... and it's going to hit us like a ton of cold-rolled steel, because the earnings you are pricing the multiple off of are getting pulverized, so it's not cheap when it's trading at 2x earnings... if those earnings are about to vanish... United States Steel Corp. (X) has already taken a first-class beat down, but the analysts are just getting started with the estimate cuts and the downgrades, which means it could go much lower.

Read Jim's next Segment here