Market May Have Overreacted To U.S. Steel's Guidance Cut, Says Morgan Stanley

The shares have lost roughly 30 percent since the earnings release.

Asset Revitalization Costs To Dwindle With Years

In a note released Sunday, Morgan Stanley said the market overreacted last week. The $1.6-billion hit to the market capitalization the stock took last week, according to the firm, implies the $400-million hit from the asset revitalization program could persist for a full four years and even grow somewhat after factoring in the present value discount.

However, analyst Evan Kurtz thinks otherwise. The analyst believes the first year of an asset revitalization program is the worst, and in the subsequent years, things should look up as an increasing number of refurbished assets will be added to the mix, lowering costs and boosting volumes.

Stock Discounting Higher Than Normal Costs

The firm noted the company effectively cut about $400 million from its 2017 EBITDA guidance on higher costs while the asset revitalization is underway for three to four years.

"On our math, the stock is now discounting $556/t flat-rolled costs (excluding purchased raw materials and legacy liability costs), in perpetuity," the analyst said.

"This is well above the $512/t average of the past five years, and only breached once in 2009 when operating rates plummeted at the depths of the global financial crisis."

Buyers On This Pullback

The firm is of the view that the asset revitalization program should significantly lower costs once it is complete.

Even with a $900-million cut to its 2018 EBITDA estimate on much higher costs, the firm noted the stock is trading only at 4.5 times its EBITDA. The firm considers the multiple to be low, even for a year that doesn't include temporary cost headwinds.

Consequently, the firm said it would be buyers on this pullback.

U.S. Steel Could Outperform In Next Price Cycle

Concluding, Morgan Stanley said, "Our view is that there is still positive news to come at an industry level. The Trump administration is very supportive of steel companies and its policies may expand the spread between US and international prices even further. With sentiment bombed out, the stock would likely be an outperformer into the next price cycle, which we expect later this year."

The firm lowered its price target for U.S. Steel to $34 from $48, while it stayed Overweight on the shares of the company.

At the time of writing, United States Steel shares were down 1.88 percent at $21.90.