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Is It Time for Steel?


U.S. Steel's market cap of $10.44 bln is right in the sweet spot in terms of price for a potential suitor.

"Early in the morning factory whistle blows
Man rises from bed and puts on his clothes
Man takes his lunch walks out in the morning light
It's the working, the working, just the working life"
- Factory (Bruce Springsteen)

All the great songwriters are in their purest form, great storytellers. Bruce may be the best storyteller of them all. Off Darkness On The Edge Of Town, Factory was written by Bruce about his father. Whenever I heard the song, it would conjure up visions of steel mills in Pennsylvania -- vivid images of men trudging off to work on a grey morning as black smoke billowed from the smokestacks in the background. Well, of course I heard the song again this morning and it immediately made me think of U.S. Steel (X), a stock I have been watching for some time.

U.S. Steel was founded in 1901 as the largest business enterprise ever launched. The founding fathers of U.S. Steel read like a who's who of American industry - Andrew Carnegie, J.P. Morgan, Charles Schwab and Elbert Gary. Today, more than 100 years after its launch, U.S. Steel remains the largest integrated steel producer in the United States.

Lately, however, the stock has been experiencing a bit of "metal fatigue." After making a 52 week high of $127.26 earlier this summer, letter "X" has dropped a cool 31%. 3rd quarter earnings on October 30th did little to stem the tide as its EPS of $2.27 was well short of the street consensus number of $2.63. But that tide may be turning.

Things on the valuation side are becoming somewhat compelling. At 9 times trailing and 8.50 times forward earnings U.S. Steel is trading on the lower end of their historic levels. Cheaper still when compared to AK Steel Holding Corp. (AKS) that currently trades at 20 times trailing and 11.50 times forward earnings. Yesterday, The Wall Street Journal reported that ArcelorMittal (MT) is planning a series of price increases ranging from 6% - 9% in North America and an undisclosed amount in Europe in the first half of next year. This bodes well for the other steel makers as they are likely to increase prices as well.

In that same vein, on November 15th, Credit Suisse (CS) made positive comments about some steel names of which U.S. Steel was one. The firm cited steel inventories declining to 2.6 months of supplies and that tons of steel held at U.S. service centers are now at their lowest levels in nearly a decade.

On November 19th, U.S. Steel was upgraded at Soleil Securities citing valuation and improving fundamentals. Soleil also raised its price target to $105 from $90.

What might be most compelling for U.S. Steel is the possibility of M&A activity that has swirled around the company for the last couple years. With talks heating up between Rio Tinto (RTP) and BHP Billiton (BHP) you can be certain that boardrooms of mining and steel stocks around the world are mapping out contingency plans and countermeasures. Although still the largest steel company in the United States, U.S. Steel's market cap of $10.44 bln is right in the sweet spot in terms of price for a potential suitor. Posco's (PKX) chief executive Lee Ku-taek has said on a few occasions he would support a merger with a suitable U.S. partner if the right situation presented itself. U.S. Steel is the name that routinely comes up in that discussion.

The risks to this trade are many - not least of which being a global slowdown that would crush steel prices and create a similar environment we saw for the steel makers in the late 90's into early 2003. But for now global growth appears to be in tact and strategic deals may take hold as we enter 2008 just like LBO's did earlier this year.
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No positions in stocks mentioned.

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