U.S. Steel Earnings Preview: Robust Market Conditions In U.S. To Partially Offset Impact Of Planned Maintenance Activity On Results

U.S. Steel (NYSE:X) will release its fourth quarter results on January 27 and conduct a conference call with analysts the next day. Planned maintenance activity in the fourth quarter will adversely affect year-over-year quarterly results of the Flat-rolled Products segment, which accounts for around two-thirds of the company’s revenues. ^[1] The planned maintenance activity is expected to result in higher repairs and maintenance costs and lower shipments from the segment. Improved market conditions for steel in North America in Q4 2014, as compared to the corresponding period a year ago, as well as the deconsolidation of the results of the company’s loss-making subsidiary, U.S. Steel Canada, which filed for bankruptcy protection in Q3, will partially offset the adverse impact of the planned maintenance activity on the Flat-rolled Products segment’s operating income. Lower raw materials costs and the company’s cost reduction efforts are expected to boost the results of the U.S. Steel Europe (USSE) segment, despite weak market conditions in Europe. Improved business conditions for the Tubular Products segment are expected to boost the segment’s operating income.

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Steel Demand and Prices

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. ^[2] Over the course of the 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. ^[3] This indicates strong manufacturing activity in the U.S., which was reflected in U.S. Steel’s third quarter results. Average realized steel prices for the Flat-rolled Products segment, which primarily serves customers in North America, rose 3.3% year-over-year to $777 per ton in the third quarter, from $752 per ton in the corresponding period last year. ^[4] As per estimates by the World Steel Association, steel demand in the North American Free Trade Agreement (NAFTA) region, which consists of the U.S., Canada, and Mexico, grew by 3.8% in 2014, as compared to a 2.4% fall in demand in 2013. ^[5] A strong steel demand and pricing environment in North America will positively impact the results of the Flat-rolled Products segment in the fourth 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, declined to 50.8 for December. ^[6] 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. The USSE segment’s results will be boosted by weakness in iron ore prices. Iron ore is the chief raw material in steel-making. The USSE segment primarily sources iron ore from third parties, in contrast to the company’s North American operations, which primarily rely on the company’s in-house iron ore production facilities. Thus the USSE segment is more prone to fluctuations in iron ore prices. The recent decline in iron ore prices due to weak demand and an oversupply situation will lower raw material costs and boost the USSE segment’s results. Iron ore spot prices stood at $68 per dry metric ton (dmt) at the end of December 2014, about 50% lower than at the corresponding point of time a year ago. ^[7]

Improved Business Conditions for Tubular Steel

The Tubular Products segment of U.S. Steel is primarily involved in the production and sale of Oil Country Tubular Goods (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. ^[1] 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. ^[1]

Cheap OCTG imports negatively impacted the fortunes of U.S. Steel’s Tubular Products division over the past couple of years. This was primarily because of a fall in the average realized price for this division. Realized prices for the Tubular Products division fell 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 $1,508 in the first nine months of 2014. ^[1] Gross margins for the division have correspondingly fallen from 15% in 2012 to 11% in 2013 and the first nine months of 2014. ^[4] 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. ^[8]

The results for the Tubular Steel segment will be boosted by the U.S. International Trade Commission’s (ITC) recent ruling in the Oil Country Tubular Goods (OCTG) trade case. The ITC ruled that anti-dumping duties will be levied against OCTG imports from South Korea, India, Taiwan, Turkey, Ukraine, and Vietnam.  OCTG imports from these countries account for the bulk of the imported energy-related tubular steel goods in the U.S., which were affecting the sales and realized prices of the Tubular Steel division. ^[9] The ITC ruling, along with an improved product mix as a result of a reduction in the company’s exposure to welded line pipe, will result in an improvement in realized prices for the segment in Q4. However, shipment volumes will decline as a result of the idling of the McKeesport and Bellville facilities earlier on in the 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 $495 million in margin improvements through this initiative in 2014. ^[10]  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 the Conference Call

The company’s 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 the management’s views about the impact of the recent slump in oil prices on the results of the Tubular Products segment in 2015. There is expected to be a significant reduction in upstream capital expenditure in the U.S. as a result of the weakness in oil prices. ^[11] This is likely to negatively impact the fortunes of U.S. Steel’s Tubular Products segment. 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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1. U.S. Steel’s 2013 10-K, SEC [↩] [↩] [↩] [↩]
2. Steel Billet Prices, LME [↩]
3. U.S. Manufacturing PMI, Trading Economics [↩]
4. U.S. Steel’s Q3 2014 10-Q, SEC [↩] [↩]
5. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
6. Euro Area manufacturing PMI, Trading Economics [↩]
7. Iron Ore Spot Price Chart, Y Charts [↩]
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. U.S. Steel Q3 2014 Earnings Conference Call Transcript, Seeking Alpha [↩]
11. Low oil prices to bite into 2015 U.S. shale growth: IEA, CNBC [↩]