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The Largest Steel Manufacturers Are a Buy

- By Jonathan Poland

Few sectors are as economically sensitive as the steel industry, and even top steel producers are not immune. Pro-business tax policies, a forgiving regulatory climate and solid demand for steel-intensive business should keep the sector moving up for years to come. In an industry that produced the world's wealthiest man at the turn of the 19th century, steel has been mostly taken for granted by the market. Steel production is now just an incidental player on a world stage that is dominated by China, the largest producer and importer of the metal.


Even with the current administration helping Nucor (NUE) here in the U.S., the top two steel makers to buy remain overseas - Posco (PKX) and ArcelorMittal SA (MT). While all three are definitely undervalued, Posco and ArcelorMittal have the greatest long-term potential.

ArcelorMittal

As the largest steel manufacturer in the world, ArcelorMittal relies primarily on blast furnaces to produce steel, with just shy of 20% of its production coming from electric arc furnaces. In all, it produces just over 5% of the world's steel with the majority of its sales coming from North America and Europe. This position has helped it generate billions on both the top and bottom line. In the last 12 months alone, the company booked over $5.1 billion in net income, spending only $3.3 billion in capital expenditures.

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Posco

On the other hand, Posco dominates its domestic market in South Korea with a 40% share and exports around 50% of its steel overseas, mainly to Asian countries. It has also diversified into non-steel and trading-related businesses, with close to 20% of its revenue in these new areas. In the last 12 months, the company booked upward of $1.5 billion in net income on $57 billion in sales. It is expected to pay out dividends of 3% in 2019.

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Valuation

Neither company's stock has fared well in the last year. ArcelorMittal is down from $32 to just shy of $23 a share. Similarly, Posco is down below $60 per share from a high of $86 last summer. Both companies are expected to see growth in the next several years, however. Posco is projected to reach $64 billion in sales and earn $10 per share by 2020. Over the same period, ArcelorMittal is forecasted to generate $80 billion in sales and earn over $5 per share by 2020.

If these targets are achieved, both companies could see their stock double. ArcelorMittal's five-year average earnings multiple is 8. Just getting back to that value would put the stock in the $40 range. As for Posco, it's not likely to price back at the company's five-year earnings multiple of 27, but even keeping its current price-earnings ratio of 12.8 would propel the stock to over $130 per share if it books expected earnings.

As a result, investors can play the continued growth in Asia as well as developed markets in Europe and North America while awaiting the rebalance from weakness to strength that will surely help stock multiples expand for both companies.

Disclosure: I am not long or short MT or PKX.

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This article first appeared on GuruFocus.