U.S. Steel Earnings Preview: Higher Steel Prices And Cost Savings To Boost Results

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United States Steel

U.S. Steel (NYSE:X) will release its third quarter results on October 28 and conduct a conference call with analysts the next day. A better pricing environment for steel in North America in the third quarter of this year, as compared to the corresponding period a year ago, will boost the results of the company’s Flat-rolled Products segment, which accounted for two-thirds of the company’s revenues in 2013. Planned maintenace activity in the third quarter will affect production volumes and raise repair and maintence costs for the U.S. Steel Europe (USSE) segment. Results for the Tubular Products segment will suffer in the third quarter, as competition from imported oil country tubular goods (OCTGs) has diminished realized prices and margins for this segment. However, a favorable ruling from the U.S. International Trade Commission (ITC), which levied anti-dumping duties on most of these imported OCTGs, will boost the prospects of the Tubular Products segment going forward. In addition, U.S. Steel’s quarterly results will be favorably impacted by The Carnegie Way, its company-wide initiative to reduce costs and boost efficiency.

See our complete analysis for U.S. Steel


Steel Demand and Prices

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The principal consumers of steel products are the automotive, construction, appliance, machinery, equipment, infrastructure and transportation industries. The nature of business of these sectors is cyclical, with demand generally correlated with macroeconomic conditions. Thus, demand for steel products is generally correlated with macroeconomic fluctuations in the global economy.

Steel prices have fallen over the last few years, driven primarily by weak demand due to adverse macroeconomic conditions in the developed economies and an oversupply situation. This is indicated by trends in the London Metal Exchange (LME) Steel Billet Prices. [1] Over the course of last year or so, steel prices have recovered somewhat, driven by an economic recovery in the developed economies, particularly in the manufacturing sector. The Manufacturing Purchasing Managers Index (PMI) measures business conditions in the manufacturing sector of the concerned economy. When the PMI is above 50, it indicates growth in business activity, whereas a value below 50 indicates a contraction. This metric has consistently registered values of over 50 for all months in 2014 for the U.S. [2] This indicates strong manufacturing activity in the U.S., which was reflected in U.S. Steel’s second quarter results. Average realized steel prices for the Flat-rolled Products segment, which primarily serves customers in North America, rose 7% year-over-year from $725 per ton in Q2 2013 to $774 per ton in Q2 2014. ((U.S. Steel’s Q2 2014 10-Q, SEC)) Steel demand in the North American Free Trade Agreement (NAFTA) region, which consists of the U.S., Canada and Mexico, is expected to grow by 3.8% in 2014, as compared to a 2.4% fall in demand in 2013. [3] A strong steel demand and pricing environemnt in North America will positively impact the results of the Flat-rolled Products segment in the third quarter.

The Manufacturing PMI for the Eurozone has faltered somewhat lately, indicating slowing manufacturing activity. The Manufacturing PMI for the Eurozone, which stood at 54 for January 2014, has declined to 50.3 for September. [4] Sluggish manufacturing activity in the Eurozone was reflected in U.S. Steel’s second quarter results. Average realized steel prices for the USSE segment fell around 1.6% year-over-year from $702 per ton in Q2 2013 to $691 per ton in Q2 2014. ((U.S. Steel’s Q2 2014 10-Q, SEC)) With faltering economic growth and manufacturing activity, as indicated by the manufacturing PMI figures, steel demand and pricing is expected to remain weak in Europe. This will negatively impact USSE’s third quarter results. In addition, planned maintenance activity will reduce production volumes and increase repair and maintenance costs for the division in the third quarter.

Challenges in Tubular Steel

The Tubular Products segment of U.S. Steel is primarily involved in the production and sale of OCTGs. These goods serve customers in the oil, gas and petrochemicals markets. Energy related tubular products imported into the U.S. accounted for approximately 49% of the U.S. domestic market in 2013. These imported OCTGs are priced significantly lower than U.S. Steel’s tubular products. U.S. Steel and other domestic steel producers had sought the imposition of anti-dumping duties and countervailing duties against these imports, claiming that these products were priced unfairly low. ((U.S. Steel’s 2013 10-K, SEC))

Cheap OCTG imports have negatively impacted the fortunes of U.S. Steel’s Tubular Products division. Segment income from operations for the Tubular Products division fell nearly 48% from $366 million in 2012 to $190 million in 2013. [5] This was primarily because of a fall in the average realized price for this division. Realized prices for the Tubular Products division have fallen due to competition from cheap OCTG imports. The average realized price per ton fell from $1,687  in 2012 to $1,530 in 2013, and further to $1,479 in the first half of 2014. [5]((U.S. Steel’s Q2 2014 10-Q, SEC)) Gross margins for the division have correspondingly fallen from 15% in 2012 to 11% and 10% in 2013 and the first half of 2014, respectively. [5]((U.S. Steel’s Q2 2014 10-Q, SEC))

The company had announced the idling of two facilities producing tubular steel earlier on in the year, citing difficult business conditions created primarily by the imports of tubular goods. ((U. S. Steel To Idle Two Tubular Facilities In Pennsylvania And Texas; Foreign Dumping Of Unfairly Traded Tubular Products A Contributing Factor, U.S. Steel Press Release))

The U.S. International Trade Commission (ITC) recently ruled that anti-dumping duties would be levied against OCTG imports from South Korea, India, Taiwan, Turkey, Ukraine and Vietnam, with imports from the Philippines and Thailand exempted from additional duties.  Imports from the Philippines and Thailand were a part of the U.S. Department of Commerce (DOC) ruling on additional duties on OCTG imports. Imports from Saudi Arabia, which were a part of the original complaint made by domestic steelmakers, were exempted from additional duties as a part of an amended final determination by the DOC. (( U.S. steel pipe makers win key anti-dumping case against cheap imports, Reuters)) The ruling has boosted the prospects of the Tubular Products segment going forward. However, competition from OCTG imports is expected to adversely impact the division’s third quarter results year-over-year.

The Carnegie Way

With a subdued steel pricing environment prevailing in 2013, the company had launched an initiative known as ‘The Carnegie Way’, which is focused on cost reductions and improvements in operational efficiency. The company is expected to realize $435 million in margin improvements through this initiative in 2014. ((U.S. Steel Q2 2014 Earnings Conference Call Transcript, Seeking Alpha)) Cost savings under The Carnegie Way initiative are an integral part of the company’s strategy to remain competitive and will boost the company’s profitability.

Expectations from Conference Call

The company management is expected to give its outlook on shipments and price realizations for the next quarter. We would be looking at the management’s expectations for its USSE segment, in order to better understand the extent of the impact of the prevailing economic weakness in Europe upon the company’s operations. We would also like to hear from the management how the favorable ITC ruling will impact the Tubular Products segment in terms of sales and price realizations going forward. Further, details regarding initiatives to be undertaken under The Carnegie Way initiative will be of interest to us. This will throw some light on the road ahead for U.S. Steel.

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Notes:
  1. Steel Billet Prices, LME []
  2. U.S. Manufacturing PMI, Trading Economics []
  3. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  4. Euro Area manufacturing PMI, Trading Economics []
  5. U.S. Steel’s 2013 10-K, SEC [] [] []