U.S. Steel (NYSE:X) announced on Monday last week that it has received interest from buyers for its Slovakian operations. However, it denied on Saturday that it had concluded a deal to sell its Slovakian steel operation to the Ukrainian company Metinvest. The Slovak economic daily Hospodarske Noviny cited sources as saying that an agreement had been signed late on Friday. 
U.S. Steel operates in Slovakia through its subsidiary U.S. Steel Kosice (USSK). It is Slovakia’s largest private corporate employer with more than 11,000 staff including subsidiaries and reported last Monday that investors had expressed interest in buying it. The identities of potential investors have not been disclosed due to confidentiality agreements.
If the sale of the Slovakian business goes through, it will end U.S. Steel’s presence in Europe. It has already sold its loss-making Serbian operations in January this year. We think that the major factors driving U.S. Steel’s decision to sell the Slovakian business are the bleak economic outlook in Europe and the potential financial liabilities it may incur on account of new environmental regulations to be enforced by January 2013.
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U.S. Steel had acquired the former government-owned Kosice plant in 2000 for $475 million and expanded its European operations three years later with the $33 million acquisition of Serbia’s government-owned steel producer. However, the European crisis has severely battered its European operations. To cut losses, on January 31 this year U.S. Steel sold its Serbian plant back to the government for a token price of $1. It had to take a charge of $450 million in the first quarter this year on account of losses in the business. The company had intended to shut down the plant but the government took over instead in order to protect the jobs of 5,400 workers as well as 15,000 more people employed with supplier companies. 
The Slovakian plant caters to the automotive industry and other higher-margin customers. It has an annual production capacity of 5 million tons, including two coke batteries, three blast furnaces and other operations that produce sheets, tin mill products and pipes. It posted operating income of $27 million in the first nine months of the year on shipments of 2.9 million tonnes. By comparison, U.S. Steel’s North American flat roll business shipped 12 million tonnes during the same period and generated operating income of $389 million. The USSK results are an improvement over last year’s operating loss of $73 million, primarily due to lower raw material costs and higher shipments.
However, the improved results this year cannot mask the fact that the economic outlook in Europe isn’t looking good for the next few years which may take a toll on demand. Also, U.S. Steel estimated in its latest 10-Q report that it will have to spend $350-400 million by 2016 to comply with new European Union (EU) environmental mandates that the Slovak Republic must adopt by January. The new laws will also increase operating costs which U.S. Steel says it cannot estimate right now.
The EU’s Industry Emission Directive will require implementation of EU determined best available techniques (BATs) to reduce environmental impacts as well as compliance with BAT associated emission levels. It contains operational requirements for air emissions, waste water discharges, solid waste disposal and energy conservation, dictates certain operating practices and imposes stricter emission limits. We believe that U.S. Steel thinks that it may not be worth making such a large investment when there seem to be no benefits in staying put. It may see more value in concentrating on its core markets in North America. 
According to some industry analysts, Russian and Ukrainian producers may be interested in buying the Kosice plant. We think that ArcelorMittal is unlikely interested because it is reducing costs right now by selling its own plants in Europe. It reported a $709 million loss in the third quarter and also desperately needs to reduce its debt pile which has led S&P, Fitch and Moody’s to downgrade its bond rating to below investment grade over the last few months.
We have a price estimate of $19 for U.S. Steel and are in the process of revising our model in light of the recent earnings results.Notes: