U.S. Steel Stock Burns the Bears With Surprise Upside Move

Key Points

• United States Steel stock has given investors a new reason to consider the stock again, especially with a massive bull case coming up now. 
• A potential merger opportunity might call for an even higher valuation premium, backed by price action.
• Market sentiment placed a premium on United States Steel, knowing that the ceiling is much higher.

Evaluating the sentiment in any underlying stock is as simple as checking who is buying (and how much) and who is selling. However, seeing unusual buying or selling activity is only half the equation; the other half is up to investors to figure out whether these buyers or sellers are right in their decisions to position themselves. Reverse engineering these positions can help these investors form a tentative thesis of their own.

After this step, an opportunity arises in two ways, and this is the nature of today’s findings in shares of United States Steel Co. NYSE: X. The first way an opportunity in the basic materials sector arises from spotting these buy or sell volumes is for investors to follow the underlying thesis and profit from the stock in question.

The second way to take advantage is to take the other side of the bet, so long as the decisions made by these larger investors do not align with the fundamental evidence that underlies the stock and its business.

As it turns out, some large positions have been opened to bet against United States Steel stock, and analyzing this decision might lead investors to a conclusion that could turn this view into a profitable opportunity.

What’s Happening Under the Surface

Over the past month alone, United States Steel stock reported a 19.6% increase in its short interest. This serves as a clear indication that bearish traders are leaning on a confident belief that the stock has nowhere to go but lower from its current level.

With this in mind, now those looking to buy have to face up to $1.2 billion worth of short positions open for United States Steel, not a light wall to attempt crashing against. Of course, the short thesis at the moment might be founded on what seems to be pretty reliable grounds; at least, that’s today’s view.

With President Trump's recently implemented trade tariffs, global trade and demand for steel may be put on the back burner for most businesses and economies around the world. However, there must be a reason why United States Steel now trades near a new 52-week high; if there were truly any traction to a bearish view, this wouldn’t be the case.

Now that some countries have started to agree on trade terms with the United States, chances are that the business cycle will be kick-started back up again, creating a very real tailwind for the steel industry and this company to keep on churning higher levels.

A New Path Forward for United States Steel

This issue has been ongoing for a couple of years, but President Trump has authorized the sale of United States Steel to Japanese steelmaker Nippon Steel. Under this agreement, the two can partner as long as a national security disclosure agreement is in place, removing most of the concerns that previously prevented the deal from taking place.

This creates a tremendous opportunity for current shareholders and prospective buyers. Considering that the deal has yet to be finalized and put on the table, with no bids placed as of yet, investors truly have no idea how much United States Steel could (or will) sell for as a business.

One thing is clear: shareholders are likely to reject any offer remotely close to where the stock trades today. In fact, after rallying by up to 50.5% over the past 12 months, it wouldn’t be far off to command a 50% premium on today’s price, given that next year it could pull off another such rally.

Perhaps seeing the writing on the wall, institutional investors from Dimensional Fund Advisors decided to boost their stakes in United States Steel stock by as much as 7.3%, bringing their entire position to a high of $421.4 million today. These insiders wouldn’t be up to buying an already hot stock if they doubted a bid could offer an additional premium.

More than that, as the short sellers build a massive billion-dollar short position, their bets could soon turn to losses the morning (or evening) this deal is announced. In other words, forcing short sellers to close out and cut their losses could create additional buying pressure, potentially driving United States Steel stock to new highs.

This is especially so considering that United States Steel stock trades at a price-to-earnings (P/E) ratio of up to 36.8x today, a steep premium compared to the steel mill industry’s average valuation of only 18.0x today.

As markets always have a reason to overpay for stocks they believe can outperform the broader market, there is a strong enough reason for this steelmaker today; not only that, but there is also a clear catalyst to come into the company in the short-term future.