U.S. Steel Earnings Preview: Improved Market Conditions In U.S. And Cost Savings To Boost Q1 Results

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U.S. Steel (NYSE:X) will release its first quarter results on April 28 and conduct a conference call with analysts the next day. Improving market conditions for steel in North America are likely to boost the results of the company’s U.S. Flat-rolled steel operations, which account for around 60% of the company’s consolidated revenues. [1] However, the company’s European operations, U.S. Steel Europe (USSE), will be negatively impacted by the depreciation of the Euro versus the U.S. Dollar, with pricing likely to be under pressure in Q1, like much of 2014. The company’s U.S. Tubular Steel operations will be negatively impacted by weak demand as a result of the ongoing weakness in oil prices. Given the mixed prospects for U.S. Steel as a whole, the company’s ongoing cost reduction initiatives will play an important role in boosting its results.  In this article, we will take a look at what to expect from the company’s Q1 results.

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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. [2] Over the course of the last year or so, demand has 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 the U.S. so far in 2015 [3] This indicates strong manufacturing activity in the U.S., which was reflected in U.S. Steel’s fourth quarter results. The average realized price for the division rose 2.4% year-over-year to $775 per ton in Q4 2014, indicating rising demand. [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, is expected to gr0w by 3.4% in 2015, following on from a robust 3.8% in 2014 and significantly higher than the 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 first quarter.

The Manufacturing PMI for the Eurozone has also registered values over 50 so far in 2015. [6] Though manufacturing activity in Europe is not as robust as the U.S., demand for steel is expected to grow at 3% in the EU in 2015. This would boost volumes for the European operations in Q1. However, pricing and margins for the European operations in Dollar terms are likely to remain under pressure, due to the strengthening of the U.S. Dollar. USSE’s revenues are denominated in Euros, but costs are denominated  in both Dollars and Euros. The average realized price for the division fell 13% year-over-year to $600 per ton in Q4 2014, primarily due to the weakening of the Euro. [4] Thus, pricing pressures on U.S. Steel’s European operations are likely to weigh on the company’s Q1 results.

Mixed 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 52% of the U.S. domestic market in 2014. [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. [7]

Cheap OCTG imports have 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. [7] Gross margins for the division have correspondingly fallen from 15% in 2012 to 11% in both 2013 and the first nine months of 2014. [8] The company had announced the idling of two facilities producing tubular steel earlier in 2014, citing difficult business conditions created primarily by the imports of tubular goods. [9]

The results for the Tubular Steel segment will be boosted by the U.S. International Trade Commission’s (ITC) ruling in the Oil Country Tubular Goods (OCTG) trade case, announced in Q3 2014. 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. [10] 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. This is expected to benefit pricing in Q1 as well.

However, weakening drilling activity in the U.S. due to weak oil prices has negatively impacted the demand for the company’s tubular steel products. As a result of weak demand, the company announced plans to idle two plants producing tubular steel earlier on in January. The two plants combined produce around 800,000 tons of tubular steel. [11] To put this into context, U.S Steel’s tubular steel shipments stood at 1.74 million tons in 2014. [1] This will negatively impact the division’s shipments in 2015.

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 realized $575 million in margin improvements through this initiative in 2014. [12]  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. Projects under the Carnegie Way initiative will boost the company’s margins by $150 million in 2015. [12]

Given the mixed business prospects for the company as a whole, the Carnegie Way initiative will play an important role in boosting margins in Q1 and the rest of 2015.

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Notes:
  1. U.S. Steel’s 2014 10-K, SEC [] [] []
  2. Steel Billet Prices, LME []
  3. U.S. Manufacturing PMI, Trading Economics []
  4. U.S. Steel’s Q4 2014 Earnings Release, SEC [] []
  5. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  6. Euro Area manufacturing PMI, Trading Economics []
  7. U.S. Steel’s 2013 10-K, SEC [] []
  8. U.S. Steel’s Q3 2014 10-Q, SEC []
  9. 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 []
  10.  U.S. steel pipe makers win key anti-dumping case against cheap imports, Reuters []
  11. U.S. Steel Lays Off 756, Blaming Low Oil Prices, Wall Street Journal []
  12. U.S. Steel Q4 2014 Earnings Conference Call Transcript, Seeking Alpha [] []