This Just In: More Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Forecast cloudy, with a chance of rust
It's hard out here for a steelmaker. At last report, Chinese mills were churning out steel at the rate of 749 million metric tons annually. That's 10% above the country's prior peak output. And lately, with an economic slowdown crimping domestic demand, China's been forced to export the excess abroad.

Result: Chinese steel exports grew 28% in the first four months of this year. And as steelmakers in other countries cut back production, analysts are warning that "cut-price Chinese exports are taking market share" from other steelmakers.

Goldman calls it
If all this sounds familiar, well, it should. Last fall, Goldman Sachs warned investors that steel supply was exceeding demand, and that this would have a deleterious effect on prices heading into 2012. In a report on U.S. Steel (NYS: X) back then, the banker warned that earnings estimates were "too optimistic," and counseled investors to sell the stock.

This week, Goldman's back with more bad news -- and this time it's shareholders of AK Steel (NYS: AKS) on the receiving end. Yesterday, Dahlman Rose cut AK to "hold" on "cash flow concerns." In no time at all, Goldman followed up with a downgrade of its own -- to "sell."

Warning of "continuing weak flat steel prices," and blasting AK for touting a "highly leveraged balance sheet, high pension funding requirements, high capex to fund its raw material strategy, and no sign of a turnaround in its lucrative electrical steel end market," Goldman sees little reason to stick around for the endgame. It may be right.

China to the rescue?
For all that it's Chinese overcapacity that's threatening the market, steel bulls are still placing many of their hopes for a recovery on China itself.

Recently, news of a $23 billion plan to support steel projects in China buoyed hopes for greater iron sales at Rio Tinto (NYS: RIO) and BHP Billiton, key suppliers to the Chinese steel market. If the infrastructure investments do appear, this would increase steel demand "at home" in China and, likely, reduce margin-crushing steel exports from China. At the same time, TheWall Street Journal is reporting that some of China's smaller mills, at least, are beginning to cut back on production -- which would likewise help to sap the steel glut, and support prices.

Foolish takeaway
Assuming the news is true, could this mean Goldman is wrong about AK Steel? Will China's moves be enough to save AK?

Not necessarily. It's been four years since AK last ended a year with a profit, and five years since it generated any positive free cash flow whatsoever. Burning cash and mired in debt (more than $1 billion), AK still looks like anything but a buy. Here at the Fool, we've got three stocks we think are much better positioned to profit from an industrial recovery than AK and its fellow steelmakers. (Read all about them here, in our new report: "The Future Is Made in America.")

If, on the other hand, you're dead set on investing in steel, and think China really is riding to the rescue this time, I'd suggest you avoid debt-laden cash-burners like AK Steel, and focus instead on efficient, free-cash-flow-positive companies like Nucor (NYS: NUE) and Steel Dynamics (NAS: STLD) . They may not be the absolute best ways to play the New Industrial Revolution, but they're much safer bets than AK.

At the time thisarticle was published Fool contributorRich Smithholds no position in any company mentioned, butMotley Fool newsletter serviceshave recommended buying shares of Nucor.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors.The Motley Fool has adisclosure policy.

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