U.S. Steel (NYSE:X) has promoted Mario Longhi, who is also President & Chief Operating Officer, as CEO effective September 1.  Longhi comes in at a challenging time for the company. There is a massive oversupply of steel in the global market. The company is struggling with high legacy costs in the form of pension benefits and old machinery at mills, its wage costs are higher than its rivals, aluminum is giving tough competition to steel in the automotive market, and imports are rising. To top it all, the company has not shown a profit for four consecutive years now and its stock price has almost halved since the time John Surma, the outgoing CEO, took charge. The company’s stock reached a record high of $196 in 2008, and it it currently trades at $18-19 per share. ((Can U.S. Steel stage comeback?, Pittsburgh Post-Gazette))
In the first part of this two-part article, we take a detailed look at the challenges facing U.S. Steel. The second part will deal with the company’s measures to counter those and plans for future growth.
- To What Extent Could U.S. Steel’s Recent Stock Offering Improve The Company’s Indebtedness?
- Why We’re Revising Our Price Estimate For U.S. Steel To $25
- U.S. Steel’s Q2 2016 Earnings Review: Cost Reduction Initiatives Boost Results Amid Weakness In Steel Prices
- U.S. Steel’s Q2 2016 Earnings Preview: Improved Business Conditions In The U.S. And Cost Reduction Initiatives To Prop Up Results
- Why We’re Raising Our Price Estimate For U.S. Steel To $18
- Why Do China’s Steel Exports Remain At Elevated Levels?
Issues Facing U.S. Steel
1) High Employee And Pension costs
U.S. Steel’s wage costs are on the higher side. This is largely due to the unionized nature of its workforce which is represented by the United Steelworkers (USW) union, the nation’s largest industrial labor union. Many of its competitors are non-unionized. According to the Wall Street Journal, the wages at its non-unionized Pro-Tec Coating Company plant near Detroit are $20 per hour compared to $20-27 per hour at the largely unionized Gary Works plant. ((The New Face of U.S. Steel: Fewer Workers, Lower Pay, WSJ))
However, U.S. Steel will have to do more to reduce wage costs because its agreements with the USW stipulates that the ratio of non-USW to USW employees shouldn’t exceed one to five. These agreements are applicable to most employees of the company’s domestic facilities. The USW has so far not succeeded in unionizing the workforce at the new Pro-Tec plant. ((U.S. Steel 2012 10-K, SEC))
Also, like other companies of the early 20th century, U.S. Steel has a defined benefit structure for its pension plans. This is not the favored option among newer companies which prefer the defined contribution plan model that reduces their payout obligations. At the end of 2012, U.S. Steel had $2.7 billion in unfunded pension liabilities. These have ballooned from $381 million at the end of 2004, largely due to record low interest rates in the intervening period. The company is bogged down by pension expenses for 142,000 former employees, some of whom retired decades ago. In addition, its retiree medical and life insurance plans were underfunded by $2.2 billion at the end of 2012. The underfunded amount is effectively debt for the company, and the sheer extent of it is a big negative for its valuation.
2) Competition From Aluminum In The Auto Industry
The new U.S. Corporate Average Fuel Economy (CAFE) standards demand better fuel economy in vehicles from auto manufacturers. This can be achieved by replacing steel with aluminum to make vehicles lighter. Companies like Alcoa have been working actively with auto manufacturers to supply them with sheets that are lighter than steel but just as tough. If steel companies don’t innovate, they are likely to see an erosion in demand from this segment. Alcoa projects that aluminum intensity per vehicle is likely to rise to 136 pounds by 2025 from the 2012 level of just 14 pounds. This represents a mind-boggling ten-fold increase and, if realized, will come at the cost of replacing steel. ((Alcoa Q2 2013 Earnings Presentation, SEC))
3) Rising Imports
The rising tide of imports into the U.S. has led U.S. Steel and other major producers to ask for duties on imported oil and tubular country goods (OCTG) which are supposedly being sold at unfairly low prices. This has prompted the U.S. Commerce Department to launch an investigation into alleged unfair trade practices being followed by exporting countries. On August 16, the U.S. International Trade Commission voted that there was a reasonable indication that U.S. manufacturers are injured by imports of OCTG goods from the countries mentioned in the complaint. This has allowed the Commerce Department to continue with its investigations. It will take a preliminary decision on duties in the coming months and a final decision in 2014. 
Imports of OCTG steel from the nine countries under investigation (India, Vietnam, Philippines, Thailand, Taiwan, Turkey, Saudi Arabia and Ukraine) totaled $1.8 billion in 2012. The quantity has more than doubled since 2010, owing to rising U.S. oil and natural gas production which is increasing demand for OCTG steel. Given the high price realizations from OCTG grades of steel and the fact that they account for 15% of its revenues, U.S. Steel has a significant stake in ensuring a favorable outcome from the investigation. 
Until the time the investigation concludes, U.S. Steel’s OCTG business is likely to continue facing challenging business conditions from imported products.
4) Excess Global Production Capacity
U.S. Steel’s problems are being compounded by the fact that production capacity of nearly 200 million tonnes is lying idle in the global market, pushing down prices. Chinese steelmakers have not cut production to the extent required to maintain profitability for fear of losing market share. This renders the demand-supply dynamic largely irrelevant for prices because China is set to produce nearly 800 million tonnes of steel this year, almost half the global production. ((China Crude Steel Output Is Set to Hit a Record, WSJ))
In the next part of this article, we shall look at the measures that U.S. Steel is taking to counter the challenges facing it and the growth avenues it is seeking to battle falling prices and increased competition.
We have a price estimate of $18 for U.S. Steel.Notes: