The Year 2014 In Review: Improving Market Conditions And Cost Reductions Boost U.S. Steel’s Performance

The year 2014 for U.S. Steel (NYSE:X) was marked by a significant improvement in its operating results, as compared to the previous year. This was mainly due to improved market conditions for steel in the U.S. and the success of the company’s efforts to reduce operating costs and increase operational efficiency. However, the company continued to face challenging market conditions in Europe. The year 2014 also provided a major boost to the prospects of the company’s U.S. Tubular Products business segment, which has been suffering due to competition from imported tubular steels. The U.S. International Trade Commission (ITC) ruled in August that oil country tubular good (OCTG) imports from six countries would be subject to anti-dumping duties. ^[1] OCTG refers to steel casing and tubing primarily used in the oil, gas, and petrochemical sectors.  The Tubular Products segment is primarily engaged in the production of OCTGs.

In other developments, U.S. Steel’s loss-making Canadian unit, U.S. Steel Canada, applied for bankruptcy protection in September. U.S. Steel Canada was deconsolidated from U.S. Steel’s financial statements in September. In this article, we will look back at how U.S. Steel fared in 2014.

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Improving Market Conditions for Steel in the U.S.

The principal consumers of steel products are the automotive, construction, appliance, machinery, equipment, infrastructure, and transportation industries. The nature of business in 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.

The year 2014 was characterized by improved economic conditions in the U.S., 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 results for the first nine months of the year. Average realized steel prices for the Flat-rolled Products segment, which primarily serves customers in North America, rose 5.5% year-over-year to $771 per ton in the first nine months of 2014. ^[3]  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. ^[4] Steel demand in the NAFTA region is expected to grow at 3.4% in 2015. ^[4] A robust steel demand and pricing environment in North America will positively impact the results of the Flat-rolled Products division in 2015.

In addition, the company announced that its Canadian unit, U.S. Steel Canada, will apply for bankruptcy protection after posting operating losses for five consecutive years, aggregating $2.4 billion. ^[5] The financial information pertaining to U.S. Steel Canada was deconsolidated from the company’s financial statements in September. The exclusion of this loss-making unit will also boost the company’s margins in 2015.

In contrast to the robust demand and pricing environment in the U.S., demand for steel remains muted in Europe. The Manufacturing PMI for the Eurozone has faltered somewhat in the second half of the year, indicating slowing manufacturing activity. The Manufacturing PMI for the Eurozone, which stood at 54 in January 2014, has declined to 50.8 in December. ^[6] Sluggish manufacturing activity in the Eurozone was reflected in U.S. Steel’s results for the first nine months of the year. Average realized steel prices for the U.S. Steel Europe (USSE) segment fell around 3% year-over-year to $691 per ton in the first nine months of 2014. ((ref:3)) However, shipments rose around 3% to 3.07 million tons over the same period. ^[3] With weak economic conditions prevailing in Europe, the USSE segment may continue to face challenging business conditions in 2015. Things may improve if economic growth recovers faster than expected in Europe.

Tubular Products Segment

The Tubular Products segment was boosted by a favorable regulatory ruling against imported tubular steels in 2014. Energy related tubular products imported into the U.S. accounted for approximately 49% of the U.S. domestic market in 2013. ^[7] 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.

Competition from cheap OCTG imports have negatively impacted realized prices and margins for the Tubular Products division. The average realized price per ton fell from $1,687  in 2012 to $1,530 in 2013, and further to $1,508 in the first nine months of 2014. ^[6] Gross margins for the division have correspondingly fallen from 15% in 2012, to 11% in 2013, and the first nine months of 2014, respectively. ^[6] The company 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. ^[8]

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. ^[9] The imposition of anti-dumping duties on OCTG imports from South Korea is extremely significant as these imports were worth around $818 million in 2013, much more than the combined value of tubular imports from the other countries involved in the case. ^[7] The favorable ITC ruling should significantly lessen the competition for U.S. Steel’s Tubular Products division from imported OCTGs and boost the division’s realized prices and margins.

A potential challenge for the Tubular Products segment next year is the prevailing environment of low crude oil prices. As per statements from the International Energy Agency (IEA), around 98% of crude oil and gas production from the U.S. has a breakeven price of below $80 per barrel and 82% has a breakeven price of $60 per barrel or lower. ^[10] Though the current level of oil prices may not result in a significant drop in production levels, it will certainly have an impact upon new projects being undertaken. As per IEA estimates, there could be a 10% reduction in upstream capital expenditure in the U.S., if current levels of oil prices prevail. ^[11] This could negatively impact the demand for tubular steel in the U.S. and consequently, the demand for OCTGs produced by the Tubular Products segment.

Cost Reduction

Given the recovering global steel demand and pricing environment, the company’s efforts to reduce its operating costs and increase the efficiency of its operations have played a major role in boosting its profitability.

The Carnegie Way is U.S. Steel’s company-wide initiative aimed at improving the efficiency of its operations and rationalizing operating costs.  Improvements in manufacturing processes, supply chain and logistics as well as reductions in selling general and administrative expenses are the main areas where the benefits of initiatives undertaken under The Carnegie Way have been realized. ^[12] Projects undertaken under this initiative will translate into an improvement in margins to the tune of $495 million for the whole of 2014. ^[13] The Carnegie Way has played an important role in boosting U.S. Steel’s profitability.

Outlook

Improving economic conditions in the U.S. should present an opportunity for U.S. Steel to further enhance the profitability of its operations next year. Though economic conditions in Europe could remain subdued in 2015, falling iron ore prices should reduce input costs for the company’s European operations. Iron ore is the chief raw material in steelmaking.  USSE (U.S. Steel Europe) sources its iron ore from third parties, in contrast to the company’s U.S. operations, where the company has its own iron ore pellet production facilities. These facilities cover a significant portion of the company’s iron ore requirements in the U.S.  Iron ore prices have fallen around 40% this year and are expected to fall further next year. ^[14] Lower input prices should support the margins of the company’s European operations.  Taking all these factors into consideration, U.S. Steel is in a good position to boost its profits in 2015 and beyond.

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1. U.S. steel pipe makers win key anti-dumping case against cheap imports, Reuters [↩]
2. U.S. Manufacturing PMI, Trading Economics [↩]
3. U.S. Steel’s Q3 2014 10-Q, SEC [↩] [↩]
4. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩] [↩]
5. U.S. Steel’s Canada Unit to Seek Bankruptcy Protection, Wall Street Journal [↩]
6. Euro Area manufacturing PMI, Trading Economics [↩] [↩] [↩]
7. U.S. Steel’s 2013 10-K, SEC [↩] [↩]
8. 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 [↩]
9. U.S. steel pipe makers win key anti-dumping case against cheap imports, Reuters [↩]
10. Low oil prices to bite into 2015 U.S. shale growth: IEA, CNBC [↩]
11. ref:7 [↩]
12. U.S. Steel’s Q3 2014 Earnings Presentation, U.S. Steel Website [↩]
13. U.S. Steel Q3 2014 Earnings Conference Call Transcript, Seeking Alpha [↩]
14. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg [↩]