U.S. Steel (NYSE:X) is looking at the cheap and abundant supply of domestic natural gas to reduce its soaring input costs. Like many other steel companies worldwide, U.S. Steel is going through tough times thanks to the slowdown in demand and rising energy, labor and other input costs. U.S. Steel is an integrated steel producer of flat-rolled and tubular steel products with major production operations in North America and Europe. It competes with companies like ArcelorMittal (NYSE:MT) and Alcoa (NYSE:AA). Our current price estimate for U.S. Steel stands at $23, implying a discount of close to 20% to the current market price. We are in process of revising our price estimate for the company.
Low natural gas prices could help lift margins
According to news reports, U.S. Steel may be looking at natural gas as an alternative to coking coal. Coking coal is used in a a blast furnace as a fuel and reducing agent in smelting iron ore and constitutes significant percentage of total input cost. Recent advancements in technology have led to discovery of new deposits of natural gas, thus dragging the natural prices down to all time low of $2 per million BTU from $14 per million BTU in 2005. According to the company, the use of natural gas in some stages of production can reduce the use of rather expensive coking coal by 10% and help improve the EBITDA margins by 1%. Further, natural gas produces lower greenhouse gas than coal. However, the company may not be better off than some of its competitors due to use of blast furnace producing steel. A limited coal can be substituted with natural gas in blast furnace vis-a-vis new electric arc furnace. ((Steelmakers eye gas to cut costs, drive exports, Reuters, Mar 16 2012))
Going forward natural gas price will rise eventually following growing industrial uses. However, we expect that any increases in price are likely to be limited than other energy sources such as coking coal, electricity etc. The move by steel companies towards use of natural gas could, however, hamper the cocking coal demand in the U.S. This could affect the valuation of companies such as Alpha Natural Resources (NYSE:ANR), who derive significant value from coking coal.