U.S. Steel (NYSE:X) will announce its fourth quarter earnings on Tuesday, January 29. We expect weaker revenues and profits compared to Q3 2012. The economic environment in Europe remains challenging and the U.S. economy is recovering slowly though the automobile and construction sectors are showing encouraging trends.
China, on the other hand, is beginning to look good due to the funds provided by the government for infrastructure creation. However, those benefits will be only be realized in the first quarter of 2013 and beyond. Higher demand for steel from China could cause the steel prices to rise, resulting in higher revenues for U.S. Steel. Also, a new phenomenon being witnessed is the expansion in production capacity of steel spurred by the shale gas revolution. Cheap natural gas is reducing cost of production for steelmakers by acting as a substitute for coal in purifying iron ore.
The overall effect of all these factors, however, has to take into account the demand-supply dynamic. Currently, there are huge production surpluses in China and Europe, and imported steel is still coming into the U.S. in large quantities. The prices of steel may thus stay depressed in the face of a supply glut, negating advantages of lower costs and higher future demand.
United States Steel Corporation is an integrated steel maker with a steel making capacity of around 30 million tons, and a majority of its operations are located in North America and Eastern Europe. Flat-rolled products, tubular products and U.S. Steel Europe (USSE) are the company’s three main reporting segments.
Prices Will Weigh On Earnings
We expect average realized prices to decline across the segments as steel prices on the London Metal Exchange (LME) are trending lower compared to the previous quarter. The ongoing European debt crisis, slow Chinese growth in the previous quarter and mixed reports about the U.S. economy have contributed to the decline in steel prices on LME. ((Steel Billet Prices, LME))
We expect the company’s margins to decline mainly on steel pricing concerns and higher costs owing to higher iron ore prices in the previous quarter. However, the company is looking at low natural gas prices to cushion the impact. We expect the tubular steel segment to have performed reasonably well due to demand from the oil and gas exploration industry. However, given the typically lower capital expenditure budgets of energy companies in the fourth quarter of any year, we don’t expect a stellar performance.
European shipments will continue to decline as the Eurozone is still reeling with overcapacity in the industry. According to a company presentation given in November, U.S. Steel has formed a joint venture with Kobe Steel to produce light, ultra-high strength steel to be used in automobile manufacturing. This grade of steel is designed to meet the fuel efficiency requirements for automobiles in the years ahead. Production is expected to begin in Q1 2013. 
The company is looking to sell its steel operations in Slovakia where it operates through its subsidiary U.S. Steel Kosice (USSK). It has reportedly been in negotiations with the Slovakian government for the same over the last few days. The Slovakian facility produces 5 million tonnes of steel. 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. 
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. 
We think that it is a bit early to estimate the overall impact of the shale gas revolution on U.S. Steel. Shale exploration increases the demand for tubular steel products, and subsequent cheap natural gas prices help steel companies by acting as a substitute for coal. So at first glance this should help both revenues and lower costs. 
However, cheap natural gas also encourages capacity expansion by steel companies, leading to excess capacity and possibly lower prices. The steel prices in the U.S. already bear the brunt of high quantities of imports, particularly from China where iron ore is cheap. A supply glut might cause prices to stay low even if demand from China picks up. 
We have a price estimate of $23 for U.S. Steel which will be revised after the fourth quarter earnings results.Notes: