U.S. Steel Earnings Preview: Challenging Business Conditions To Negatively Impact Q2 Results

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U.S. Steel (NYSE:X) will release its second quarter results on July 28 and conduct a conference call with analysts the next day. [1] The company’s results are expected to be negatively impacted by challenging business conditions, arising from an increase in cheap steel imports to the U.S. and weak demand conditions for steel. These factors are likely to negatively impact both realized prices and shipments of the company’s U.S. Flat-rolled steel division, which accounts for around 60% of the company’s revenues. [2] In addition, the results of the Tubular Steel segment, which primarily serves customers in the oil and gas space, will be negatively impacted by a fall in demand as a result of subdued drilling activity. A strengthening of the U.S. Dollar against the Euro over the last twelve months will negatively impact the results of the company’s European operations. The negative impact of these external factors on U.S. Steel’s results will be partially offset by the company’s ‘Carnegie Way’ initiative, an ongoing company-wide endeavor to reduce operating costs and increase the efficiency of its operations. In this article, we will take a look at what to expect from U.S. Steel’s Q2 results.

Challenging Business Conditions

The U.S. domestic steel industry has been negatively impacted by competition from rising steel imports. Steel sheet imports to the U.S. accounted for 22% of the domestic market in 2014, up sharply from 15% of the domestic market in 2013. [3] Two important reasons for the increase in steel sheet imports are the strengthening of the U.S. Dollar and the sharp increase in Chinese steel exports. Steel imports to the U.S. have been bolstered by the strengthening of the U.S. Dollar against global currencies, which has made these imports cheaper in Dollar terms.

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The U.S. Dollar has strengthened considerably over the course of the last twelve months. The Dollar Index, which is a measure of the strength of the Dollar against a basket of other currencies, currently stands at 97, as compared to 81 twelve months ago. [4] A higher value of the Dollar Index implies a stronger U.S. Dollar.

Dollar Index, Source:Bloomberg

Though the reasons for the strengthening of the Dollar are many, basically a strong U.S. economy relative to other developed economies has helped attract foreign capital flows. The strengthening of the Dollar has made cheap steel imports even cheaper in Dollar terms, which has boosted foreign imports.

The negative impact of the strengthening of the Dollar has been compounded by a sharp increase in steel exports from China. The Chinese steel industry is currently facing weak domestic demand, primarily due to a slowing Chinese economy. Domestic demand for steel stood at 711 million tons in 2014. [5] In comparison, Chinese steel production in 2014 stood at 823 million tons in 2014. [6] This oversupply situation in the Chinese domestic steel market has provided a sharp boost to Chinese steel exports, which rose 36% year-over-year in the first four months of 2015. [7]

In addition to the competition from steel imports, prevailing demand conditions for steel in North America are fairly subdued, with the World Steel Association expecting steel demand in the North American Free Trade Agreement (NAFTA) region to decline by 0.9% in 2015. [8] This is partly due to the high base effect, with demand increasing by 12% in 2014, which was higher than expected. [9] Weak growth in U.S. steel demand has further dampened the prospects of domestic steel companies such as U.S. Steel.

The negative impact of the combination of the factors discussed above was evident in U.S. Steel’s Q1 earnings results, in which shipments for the Flat-rolled Steel segment stood at 2.62 million tons, as compared to 3.12 million tons (excluding shipments from U.S. Steel Canada, the results of which were deconsolidated from the company’s financial results in Q3 2014) in the corresponding period of 2014. [10] In addition, competition from cheap imports drove down average realized prices for the division in Q1, which fell 1% year-over-year to $768 per ton (excluding the results of U.S. Steel Canada). [10]

The strengthening of the U.S. Dollar will also negatively impact the results of U.S. Steel’s European operations in Q2. Realized prices for the segment declined roughly 25% to $530 per ton in Q1 2015, primarily as a result of the strengthening of the U.S. Dollar against the Euro, though there was some deterioration in Euro-based prices as well. [10] The decline in Dollar-based pricing will negatively impact realized prices and margins for U.S. Steel’s European operations in the second quarter as well.

Impact of Low Oil Prices on Tubular Products Segment

The decline in oil prices over the last twelve months has negatively impacted the prospect of the Tubular Products segment. U.S. Steel’s Tubular Products division produces and sells seamless and electric resistance welded (ERW) steel casing and tubing (commonly known as oil country tubular goods or OCTGs), standard and line pipe, and mechanical tubing. These goods are primarily sold to customers in the oil, gas, and petrochemical markets.

Brent Crude Oil Prices, Source: Y Charts

Brent crude oil spot prices currently stand at levels of around $57 per barrel, around 45% lower year-over-year (as illustrated in the chart shown above). As a result of the decline in oil prices, there has been a substantial reduction in drilling activity. This is reflected in U.S. rig count data, which stood at 857 at the end of last week, around 54% lower year-over-year. [11] As a result, the demand for OCTGs has declined, resulting in a 47% year-over-year reduction in the division’s shipments to 220,000 tons in Q1. [10] This trend is expected to continue in Q2 as well, with weak drilling activity weighing on the results of the Tubular Products segment.

The Carnegie Way

With a subdued demand and pricing environment for steel 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. Projects undertaken under this initiative translated into an improvement in margins to the tune of $575 million in 2014. [12] In addition, the company estimates that additional benefits of around $340 million will be realized through The Carnegie Way initiative in 2015. [13] Given the bleak market conditions for steel, initiatives taken under The Carnegie Way will play an important role in offsetting the negative impact of adverse business conditions on the company’s results. However, given the bleak business environment facing U.S. Steel, the company’s results are likely to suffer in Q2.

 

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Notes:
  1. U.S. Steel Second Quarter 2015 Earnings Conference Call and Webcast, U.S. Steel Website []
  2. U.S. Steel’s Q1 2015 Earnings Release, SEC []
  3. U.S. Steel’s Q1 2015 10-Q, SEC []
  4. Dollar Index, Bloomberg Business []
  5. Short Range Outlook 2015-16, World Steel Association []
  6. World Crude Steel Production, World Steel Association []
  7. U.S. Steelmakers Seek Antidumping Action Against China, Four Others, Wall Street Journal []
  8. Short Range Outlook 2015-2016, World Steel Association []
  9. Short Range Outlook 2014-2015, World Steel Association []
  10. U.S. Steel’s Q1 2015 Earnings Release, SEC [] [] [] []
  11. U.S. Rig Count, Baker Hughes []
  12. U.S. Steel’s Q4 2014 Earnings Presentation, SEC []
  13. U.S. Steel’s Q1 2015 Earnings Call Transcript, SEC []