U.S. Steel Q3 Earnings Preview: Weak Market Conditions To Negatively Impact Results

U.S. Steel (NYSE:X) will release its third quarter results on November 3 and conduct a conference call with analysts the next day. ^[1] We expect the company’s results to be negatively impacted by challenging business conditions impacting the U.S. steel industry, arising as a result of competition from cheap steel imports 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 nearly two-thirds of the company’s revenues. ^[2] Subdued oil and gas drilling activity is likely to negatively impact the results of the Tubular Products segment. Revenues for U.S. Steel’s European operations will be negatively impacted by the strengthening of the Dollar against the Euro over the past year. The negative impact of these 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 operational efficiency, as well as lower raw material costs, especially iron ore. In this article, we will take a look at what to expect from U.S. Steel’s Q3 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] Rising Chinese steel exports and the strengthening of the U.S. Dollar, which has made steel imports cheaper in Dollar terms, are the major reasons for the surge in steel imports.

The Chinese steel industry is currently characterized by weak domestic demand and high production levels. Domestic demand for steel stood at 711 million tons in 2014. ^[4] In comparison, Chinese steel production in 2014 stood at 823 million tons. ^[5] This mismatch between demand and production is indicative of the oversupply situation in the Chinese domestic steel market, which has provided a sharp boost to Chinese steel exports. Chinese steel exports stood at 83.1 million tons in the first nine months of the year, roughly 27% higher year-over-year. ^[6]

Besides competition from steel imports, prevailing demand conditions for steel in North America are fairly subdued. As per World Steel Association estimates, steel demand in North America is expected to decline by 0.9% for the full year 2015. ^[7] This is partly due to the high base effect, with demand increasing by 12% in 2014, which was higher than expected. ^[8]

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 87 twelve months ago. ^[9] A higher value of the Dollar Index implies a stronger U.S. Dollar. A strong U.S. Dollar has facilitated steel imports, compounding the impact of rising Chinese steel exports. A combination of competition from steel imports and weak market conditions for steel is likely to negatively impact both shipment and realized prices for the company’s U.S. Flat-rolled Steel division.

Dollar Index, Source: Bloomberg

The strengthening of the Dollar will also negatively impact realized prices for U.S. Steel’s European operations in Dollar terms. Realized prices for the segment in Dollar terms declined roughly 24% year-over-year in the first six months of the year, primarily as a result of the strengthening of the U.S. Dollar against the Euro. ^[2] A similar decline in realized prices is expected in Q3.

Impact of Weak Drilling Activity on Tubular Products Segment

Brent Crude Oil Prices, Source: Y Charts

Oil prices have declined over the course of the last twelve months, as illustrated by the chart shown above. A global oversupply situation is keeping oil prices subdued. The sharp decline in oil prices has negatively impacted drilling activity in the U.S., indicated by the sharp reduction in U.S. rig count data, which stood roughly 60% lower year-over-year at the end of October. ^[10] Weak drilling activity has negatively impacted the prospects of U.S. Steel’s Tubular Products division, which produces 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, all of which are sold to customers in the oil and gas space. The Tubular Products division’s shipments declined 80% year-over-year in the first six months of the year. ^[2] Weak demand for OCTGs is expected to negatively impact the division’s shipments in Q3 as well.

The Carnegie Way

In response to the weakness in steel demand and pricing prevailing in 2013, U.S. Steel launched an initiative known as ‘The Carnegie Way,’ which targets cost reduction and improvements in operational efficiency. Projects undertaken under The Carnegie Way initiative boosted margins to the tune of $575 million in 2014. ^[11] U.S. Steel estimates that benefits of around $590 million will be realized through The Carnegie Way initiative in 2015. ^[12] Given the lackluster prevailing market conditions for steel, The Carnegie Way will play an important role in boosting the company’s bottom line. However, as a result of the bleak business environment facing U.S. Steel, the company’s results are likely to suffer in Q3.

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1. U.S. Steel Conference Call Available On Company Website, U.S. Steel Website [↩]
2. U.S. Steel’s Q2 2015 10-Q, SEC [↩] [↩] [↩]
3. U.S. Steel’s Q1 2015 10-Q, SEC [↩]
4. Short Range Outlook 2015-16, World Steel Association [↩]
5. World Crude Steel Production, World Steel Association [↩]
6. China Buys More Iron From Abroad as Steel Exports at Record, Bloomberg [↩]
7. Short Range Outlook 2015-2016, World Steel Association [↩]
8. Short Range Outlook 2014-2015, World Steel Association [↩]
9. Dollar Index, Bloomberg Business [↩]
10. U.S. Rig Count, Baker Hughes [↩]
11. U.S. Steel’s Q4 2014 Earnings Presentation, SEC [↩]
12. U.S. Steel’s Q2 2015 Earnings Call Transcript, Seeking Alpha [↩]