U.S. Steel: 2013 In Review

U.S. Steel (NYSE:X) had a forgettable year in 2013. In the first nine months of the year, the company recorded revenues of $13.1 billion as compared to $14.8 billion in the comparable period last year. It recorded a net loss of $1.9 billion, compared to a loss of $74 million last year. While this was primarily due to a goodwill impairment worth $1.8 billion, the quantum of loss would have been greater than 2012 even otherwise. Things haven’t really improved in the fourth quarter so we expect U.S. Steel to end up with a poorer overall performance compared to 2012.

U.S. Steel was downgraded by S&P from ‘BB’ to ‘BB-‘ on expectations of a weak operating performance in the face of challenging market conditions. This shows that structural conditions in the steel market are not likely to pick up anytime soon. The company’s woes were compounded by rising imports, especially in the tubular goods space, where margins are considerably higher. Let’s examine each of these major events in detail.

We have a price estimate of $19 for U.S. Steel, which represents 34% downside to the current market price.

See Full Analysis of U.S. Steel Here

The S&P Downgrade

The rating downgrade by S&P in June 2013 put U.S. Steel three notches below investment grade rating.

Excess supply in the face of insufficient demand and high import levels continue to hinder U.S. Steel’s ability to gain higher pricing power. Thus, S&P expects a weaker operating performance from the company than its previous expectations. In addition, factors such as the capital-intensive nature of the company’s operations and the cyclical nature of the steel industry have led to U.S. Steel acquiring a high degree of operating leverage. According to S&P, the book value of U.S. Steel’s debt is relatively high and it also has significant underfunded post-retirement benefit obligations. ((S&P Cuts U.S. Steel Rating on Weaker Than Projected Operating Performance, WSJ))

The company had a long-term debt of $3.6 billion on its balance sheet at the end of Q3 this year. In addition, its retiree medical and life insurance plans were underfunded by $2.2 billion and pension plans by $2.7 billion at the end of 2012. On the operating cost front too the company is expected to face challenges due to repair and maintenance expenses as well as higher natural gas costs, especially if the U.S. allows export of liquefied natural gas (LNG) more liberally. ^[1]

Despite the rating downgrade, S&P maintained a stable outlook on U.S. Steel. This was primarily due to the company’s strong liquidity position, the extent of its operations, and the cost benefits expected to accrue from backward integration into iron ore and coke production. The liquidity position is expected to be strong enough to allow the company to withstand headwinds over the next 6 months.

Rising Imports

In 2013, the rising tide of steel imports into the U.S. led 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 prompted the U.S. Commerce Department to launch an investigation into alleged unfair trade practices being followed by exporting countries. Preliminary anti-dumping duties are expected to be imposed in February 2014.

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. ^[2]

Until the time the investigation concludes, U.S. Steel’s OCTG business is likely to continue facing challenging business conditions from imported products.

Goodwill Impairment

U.S. Steel took 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 acknowledged that they were not worth the price paid at the time. ^[3]

Of the total impairment charge, $946 million was accounted for by the company’s North American flat-rolled steel segment and $837 million by its Texas operations where tubular steel is produced. ^[4]

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. As pointed out earlier in this note, the glut in tubular steel will affect U.S. Steel’s profits quite a lot because it is the company’s most profitable segment. ^[5]

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

1. U.S. Steel 2012 10-K, SEC [↩]
2. US to probe steel pipes from Turkey, 8 others, Daily News [↩]
3. U.S. Steel new CEO expected to slash more costs, Pittsburgh Post-Gazette [↩]
4. U.S. Steel Q3 2013 10-Q, SEC [↩]
5. U.S. Steel expects $1.8 billion 3Q writedown, MarketWatch [↩]