Goodwill Impairment And Lower Prices Will Affect U.S. Steel’s Results

U.S. Steel (NYSE:X) will announce its third quarter earnings on Monday, October 28. We expect lower prices and goodwill impairment charges to result in a net quarterly loss for the company.

There is a global glut in steel production capacity at the moment and even U.S. Steel’s profitable oil and tubular goods segment is now facing this issue. This was reflected in the $1.8 billion impairment of goodwill for the third quarter which the company announced a few days back.

China reported economic growth of 7.8% for the third quarter. Earlier, a slowdown was being expected due to the belief that the country is in the process of reorienting its economy towards a consumption-led model and away from an investment-led one. The monetary stimulus provided by the Chinese government is believed to be behind the higher growth rate. Chinese steelmakers are on course to add more production capacity. If the country doesn’t consume the additional production and seeks to export instead, it will add to oversupply in the U.S. market, driving down prices further. ^[1]

We have a price estimate of $18 for U.S. Steel, which represents a 25% downside to the current market price.

See Full Analysis of U.S. Steel Here

Goodwill Impairment

U.S. Steel reported last week that it would take a $1.8 billion impairment charge on goodwill in its third quarter results. The Canadian and Texas steel mills, which accounted for this impairment, were acquired for $3.1 billion in 2007 and U.S. Steel now acknowledges that they are not worth the price paid at the time. ^[2]

Of the total impairment charge, $1 billion will be accounted for by the company’s North American flat-rolled steel segment and $0.8 billion by its Texas operations where tubular steel is produced. For the flat-rolled steel segment, U.S. Steel cited a protracted economic recovery and excess global steel production capacity as reasons for impairment. For the tubular steel operations, it laid the blame on increased market supply, announcements by other companies of further capacity addition, and increased imports. According to U.S. Steel, these factors have resulted in a low pricing environment. According to some analysts, oil and gas companies have also learned to extract more with fewer rigs, leading to lower growth in demand than expected. The glut in tubular steel will affect U.S. Steel’s profits quite a lot because it is the company’s most profitable segment. ^[3]

The data on the London Metal Exchange (LME) shows steel billet prices rising over the previous quarter. Nevertheless, U.S. Steel faces a grim pricing scenario due to oversupply in the U.S. market, as indicated above. ^[4]

Imports Are A Big Challenge

The rising tide of imports into the U.S. has prompted U.S. Steel and other major producers to ask for duties on imported oil and tubular country goods (OCTG) which are supposedly being sold at unfairly low prices. This has prompted the U.S. Commerce Department to launch an investigation into alleged unfair trade practices being followed by exporting countries.

Imports of OCTG steel from the nine countries under investigation (India, Vietnam, Philippines, Thailand, Taiwan, Turkey, Saudi Arabia and Ukraine) totaled $1.8 billion in 2012. The quantity has more than doubled since 2010, owing to rising U.S. oil and natural gas production which is increasing demand for OCTG steel. Given the high price realizations from OCTG grades of steel and the fact that they account for 15% of its revenues, U.S. Steel has a significant stake in ensuring a favorable outcome from the investigation. However, the probe is likely to take time to complete and the company’s tubular steel business is likely to continue facing challenging business conditions in the meantime. In the earnings conference call, we would be keen to know if there are any updates on this front. ^[5]

U.S. Steel may decide to shut down some of its production capacity in the face of a persistent capacity overhang. We will watch out for any queries by analysts in this regard in the earnings conference call.

Understand on Trefis how a company’s products impact its stock price

1. China’s Sept power, steel output grows strongly as economy picks up, Reuters [↩]
2. U.S. Steel new CEO expected to slash more costs, Pittsburgh Post-Gazette [↩]
3. U.S. Steel expects $1.8 billion 3Q writedown, MarketWatch [↩]
4. LME Steel Billet Prices, LME [↩]
5. US to probe steel pipes from Turkey, 8 others, Daily News [↩]