U.S. Steel (NYSE:X) will announce its first quarter earnings on Monday, April 29. We expect sequentially weaker revenues and profits. 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.
While many expected that the Chinese government’s push for infrastructure creation would boost demand for steel, it unexpectedly took measures in February to cool the housing market. More stringent rules and conditions were enforced to rein in speculation, which may have limited the demand and price upside for steel. The Chinese economic growth data for the first quarter was also disappointing and below market expectations, thus sending further negative signals for the steel market.
Also, imported steel is still coming into the U.S. in large quantities. The price of steel may thus stay depressed in the face of a supply glut, negating advantages of lower costs and higher future demand.
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- U.S. Steel Q1 2016 Earnings Review: Competition From Imported Steels And Weak Oil & Gas Drilling Activity Adversely Impact Results
- U.S. Steel Q1 2016 Earnings Preview: Adverse Business Conditions To Negatively Impact Results
Low Prices And Weak Demand 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 crisis in Europe, slow Chinese growth in the previous quarter and mixed performance of sectors in the U.S. economy have contributed to the decline in steel prices on LME. ((Steel Billet Prices, LME))
According to a report by the China Iron and Steel Association, although China has already entered the peak season for steel-consuming industries, demand is still lukewarm, building activity in the construction sector has fallen and the manufacturing sector remains weak. Inventory stockpiles are high and a delay in releasing new urbanization plans is fueling uncertainty. This paints a gloomy picture for the future price outlook as well. 
While automotive demand has picked up, there has been weakening in some of the industrial markets and energy markets according to some analysts. As a result, on average, steel mills are running considerably below full capacity. The production at U.S. Steel’s mills in North America is down by 7% from the previous year’s levels. 
Slovakian Plant Uncertainty Resolved
In the first quarter, U.S. Steel finally agreed to run its Slovakian plant for at least five more years in return for annual renewable energy subsidies worth $19 million from the government for the next 15 years. The Slovakian facility produces 5 million tonnes of steel and employs around 11,000 people. Had the plant had been shut down or sold off, it would have ended the company’s operations in Europe.
Slovakia will also provide assistance with landfill costs and help U.S. Steel pursue financial assistance from the European Union for environmental projects. The company estimates that it would need $400 million to comply with the European Union’s (EU) environmental regulations which will be implemented in March 2016. It has been exploring the possibility of getting grants from the EU to cover a portion of expected costs.
In return, U.S. Steel has resolved not to make mass layoffs at the plant through at least next year, except if there is a severe economic downturn or an adverse change in steel market conditions. It has also agreed to pay the government in case it sells the plant at some point in the next five years. If a sale occurs in the first year, $60 million will be paid. The amount to be paid will reduce progressively with time and in the fifth year the penalty would stand at $15 million. 
Items We Will Watch
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 and can be priced higher. Production was expected to begin in Q1 2013. We will be watching out for any updates regarding the same in the conference call. 
Steel imports into the U.S. have peeved the U.S. Steel management for long, which unfailingly mentions it in its investor communications as a factor eroding the competitiveness of domestic manufacturers. The management generally provides updates on the current status of the cases it is contesting against exporting countries in various forums. We will look out for updates on the same, since the outcomes of such cases have a bearing on the company’s business prospects.
We have a price estimate of $23 for U.S. Steel which will be revised after the first quarter earnings results.Notes:
- China steel prices, demand to remain low in May -industry body, Reuters [↩]
- U.S. Steel to lock out Ontario workers, The Globe And Mail [↩]
- U.S. Steel to keep Slovakian plant in return for energy subsidies, Pittsburgh Post-Gazette [↩]
- Goldman Sachs Mining Conference Presentation, U.S. Steel [↩]