U.S. Steel Stock Upgraded: What You Need to Know

Steel is back in focus on Wall Street.

After U.S. Steel (NYSE: X) reported a big earnings beat Tuesday, Wall Street wasted no time rushing to sing its praises. U.S. Steel reported a $0.61-per-share loss for its fiscal fourth quarter, but Wall Street had expected an even bigger loss -- and when calculated according to "pro forma" results (which exclude so-called one-time items) management says that U.S. Steel was actually profitable for the quarter, earning $0.27 a share where analysts had expected only $0.01.

In no time at all, investment banker Jefferies & Co.doubled down on its buy rating on U.S. Steel stock, while a short time later, Merrill Lynch weighed in with an upgrade tobuy, assigning U.S. Steel a $40 price target.

Here are three more things you need to know about the news.

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All of a sudden, steel stocks are hot again. Image source: Getty Images.

1. Merrill Lynch loves U.S. Steel

StreetInsider.com gave us a great write-up on Merrill Lynch's rerating of U.S. Steel yesterday, so let's start with that one. According to Merrill, U.S. Steel's "earnings beat" isn't the only reason the analyst has decided to upgrade the stock -- or even the main reason.

Instead, Merrill focuses on U.S. Steel's new guidance, which predicts the steelmaker will earn $1.3 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) this year -- as much as $200 million more profit that Merrill had been expecting, and $100 million more than the consensus on Wall Street. (In percentage terms, those are 18% and 8% improvements, respectively.)

2. Steel's economics improve

Merrill also notes that U.S. Steel management is allaying investor concerns about the effect of higher prices for metallurgical coal. Previously expected to rise by $30 a ton this year (adding cost to U.S. Steel's products, and squeezing profits), coal prices are now expected to rise only $19 per ton. At the same time, Merrill now sees hot rolled coil (HRC) steel prices rising to $650 per ton in fiscal 2017, alongside a "modest 2% y/y" increase in steel volumes sold, as domestic steelmakers steal share from imports.

The combination of higher selling prices for steel, higher -- but less so -- input costs, and greater sales volume, has Merrill convinced that U.S. Steel stock that costs less than $33 a share today "provides an attractive entry point." If the shares rise as high as $40, as Merrill predicts, that could mean a profit of as much as 21.5% for new investors.

3. It's not just U.S. Steel

Is that not enough good news for you? Well, get ready for some more. At the same time as U.S. Steel was getting its upgrade from Merrill Lynch, Goldman Sachs was announcing an upgrade of its own for shares of ArcelorMittal (NYSE: MT) stock.

Arcelor hasn't yet reported its earnings, but when it does (on Feb. 10), Goldman expects to see the company report at least $1.41 billion in Q4 EBITDA. That would be below consensus estimates of $1.55 billion -- but still more than enough profit to make ArcelorMittal a "conviction buy," in Goldman's view.

Like Merrill Lynch, Goldman sees 2017 as a year in which "elevated steel prices flow through to earnings" at Arcelor. And echoing Merrill's hopes about market share gains, Goldman notes that anti-dumping litigation that has been leveled at "HRC imports from Iran, Serbia, Ukraine, Russia, and Brazil" could also go Arcelor's way. As TheFly.com reports today, Goldman Sachs is raising its target price by more than 50% in response -- to the euro equivalent of $10.06 per share -- a potential 24% gain from today's share price of $8.13.

Bonus thing: Which of these steelmakers is your best buy?

So what we have here, in short, is two name-brand stock analysts, each positing 20%-plus profits on two of the biggest steelmaking stocks in the world. But which of these two is the better buy for you?

Well, let's see here. According to data from S&P Global Market Intelligence, neither U.S. Steel nor ArcelorMittal is currently profitable on a GAAP basis. But both U.S. Steel stock and ArcelorMittal are generating positive free cash flow.

U.S. Steel generated $421 million in such cash profits over the past 12 months, while Arcelor generated free cash flow (FCF) of $251 million over its four most recent-reported quarters. Weighed against their debt-adjusted market caps (also known as the "enterprise value"), that works out to a 16.4 times FCF valuation for U.S. Steel -- while Arcelor's much larger market cap, and much smaller free cash flow, means Arcelor stock sells for 145 times free cash flow.

So which one should you buy? With the caveat that this is subject to change when Arcelor reports its own updated numbers next week, for today at least, the answer seems clear: U.S. Steel is clearly the cheaper stock -- nearly nine times as cheap. U.S. Steel also pays a small dividend (0.6%), which Arcelor does not. If I were choosing between the two, U.S. Steel would seem the obvious choice.

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Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.