U.S. Steel (NYSE:X) announced its first quarter results on Tuesday with both revenue and income from reportable segments recording growth. U.S. flat rolled and U.S. tubular were the divisions primarily driving profits as a gradual recovery in the U.S. economy lent support. Falling natural gas prices also helped the company reduce its operating costs. However, tough economic conditions and an oversupply of steel in Europe aggravated losses for the company’s European operations. The company’s net income was positive for the quarter excluding a pre-tax loss of $399 million on the sale of U.S. Steel Serbia. Primary competitor ArcelorMittal (NYSE:MT) is scheduled to report its earnings on May 10.
In the wake of these earnings and other recent developments, we have revised our price estimate for U.S. Steel to $33, about 25% ahead of the current market price. We believe that outside of Europe, the company will continue to perform well in the near-term. In the U.S., automotive market growth should continue to support growth. Moreover, increasing exploration activities and expansion by energy companies should keep tubular demand intact, while keeping natural gas prices low.
Strong Quarter for Flat Rolled and Tubular Divisions
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With some recent encouraging economic reports, we believe that the U.S. is on track for a slow but steady recovery. We expect domestic consumption to continue to drive automotive sales in the U.S.. Consequently, this will result in higher flat rolled steel shipments for the company. The flat rolled division accounts for more than half of our price estimate.
Recent anti dumping regulations and countervailing duties imposed by the U.S. government to curb cheap imports should also help revive domestic steel producers. By virtue of being the largest steel maker in the U.S., we expect U.S. Steel’s American arm to benefit the most from rising domestic steel demand. We expect steel prices to increase in the near-term due to the curb on cheap imports and rising input costs.
Natural Gas Prices Provide Twofold Benefit
Falling natural gas prices have been a strong positive for U.S. Steel. Technological innovation and increases in drilling operations have led to new discoveries of natural gas deposits, pushing natural gas prices to all time lows. This increase in drilling activity is leading to greater demand for tubular steel from energy companies like Kinder Morgan Energy Partners (NYSE:KMP) and Chesapeake Energy (NYSE:CHK) as they expand their natural gas and petroleum pipeline networks. The U.S. tubular steel division accounts for about 30% of our price estimate.
Further, in the U.S., the use of natural gas in some stages of production can reduce the use of rather expensive coking coal. Accordingly, low gas prices also allow the company to reduce input costs and boost margins.
Europe Still Struggling with Oversupply, Debt Shocks
The European steel business may not recover in the near-term due to economic uncertainty in the Eurozone. We do, however, forecast an eventual increase in steel shipments in conjunction with a longer-term economic recovery. We expect steel prices to remain largely steady, mainly due to rising input costs, but any price hikes will be capped by oversupply.
We expect margins for the steel business to improve thanks to various restructuring steps taken by the company, including the disposal of the unprofitable Serbian business. These cost-cutting efforts should allow margins to remain healthy in the near-term, and eventually expand.
Company Well-Positioned in Long Term
Overall, we are cautiously optimistic about the company’s prospects as the U.S. economy is showing some signs of revival. Our concerns arise from the fact that a European recovery is likely to be a few years away, and more protracted in nature. Also, unlike many of its competitors U.S. Steel has limited exposure to developing countries, where demand growth is likely to be stronger than developed countries. Automotive manufacturers shift towards lighter weight aluminum may benefit its other competitor Alcoa (NYSE:AA).Notes:
- United States Steel Corporation Reports 2012 First quarter Results, U.S. Steel News Release, April 24 2012 [↩]