Underperforming Amid Favorable Business Conditions: The Curious Case Of U.S. Steel

May 4th, 2017 by Trefis Team
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United States Steel

U.S. Steel dismayed investors with an underwhelming Q1 earnings release last week. The company reported an unexpectedly steep decline in shipments for its U.S. Flat-Rolled steelmaking operations, which account for around 70% of the company’s revenue, translating into a significant decline in EPS. The poor Q1 2017 earnings resulted in a sharp decline in the company’s stock price over the course of the past week, as illustrated by the chart shown below.

X Stock Price Apr May 2017

U.S. Steel Stock Price, Source: Google Finance

The company attributed the decline in shipments for the Flat-Rolled division to planned production outages as it embarks upon its ‘asset revitalization program,’ which is aimed at improving the efficiency, reliability, and product quality in addition to lowering production costs. [1] However, in doing so, the company is foregoing higher production levels during a favorable time period characterized by rising steel prices and demand for the commodity in key markets.

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Improving Business Conditions for U.S. Steelmakers

The U.S. steel industry has been dogged by competition from low-priced steel imports over the past few years. Steel imports priced extremely low from countries such as South Korea and China weighed on the fortunes of domestic steelmakers, translating into declines in realized prices as well as shipment volumes. In response to petitions from domestic steelmakers, the Department of Commerce levied steep antidumping and countervailing duties on unfairly traded steel imports over the course of 2016. [2] In addition, the Trump administration has vowed to protect the domestic steel industry from unfair trade. [3] As a result of action taken by U.S. authorities, there has been a considerable improvement in the business environment for domestic steelmakers, with the lowering of competition from imported steels. The improved business conditions are reflected in the recent recovery in steel prices, with U.S. Steel reporting an 18% year-over-year increase in realized prices for the Flat-Rolled division in Q1. [4] Our pricing forecast for the division reflects the improved business conditions.

In addition to the improvement in realized prices, accelerating economic growth and the potential implementation of President Trump’s $1 trillion infrastructure plan have boosted the long term demand outlook for the U.S. [5] Outside of the U.S., similar punitive actions taken against unfairly-traded steel imports in Europe, as well as improving demand conditions, have resulted in a recovery in the European steel market, as illustrated by our forecasts for U.S. Steel’s European operations. [6]

Thus, business conditions for steel companies operating in the U.S. and Europe are conducive for significant earnings growth. However, U.S. Steel seems to have dropped the ball with the unexpected problems pertaining to its Flat-Rolled steel division.

Asset Revitalization Program

The Flat-Rolled division has been experiencing operational problems over the past few quarters. In Q3 2016, the division’s shipments were negatively impacted to the tune of 125,000 tons, or around 5% of the company’s Q3 shipments, as a result of unplanned production outages. [7] The division’s shipments fell further 6% sequentially in Q4, as a result of planned production outages. [8] The company lowered production levels in Q4 as it undertook its asset revitalization process, partly aimed at addressing operational problems leading to unplanned production outages. However, problems for the company’s Flat-Rolled steelmaking operations continued into 2017, with the accidental release of waste water from the company’s Midwest plant in Portage, Indiana, which temporarily halted operations at the plant. [9] Moreover, the company reported a 4% year-over-year decline in shipments for its Flat-Rolled division in Q1 2017, with the decline in shipments attributed to planned production outages under the asset revitalization program. [9]

The recent disruptions at the Flat-Rolled steel division’s facilities have raised concerns over U.S. Steel’s ability to increase production levels to profit from the improved business conditions for steel in the U.S. The asset revitalization program will lower the Flat-Rolled division’s shipments by around 1 million tons in 2017. [6] However, the implementation of the asset revitalization program is expected to occur in a phased manner, stretching for another two to three years beyond 2017, as the company endeavors to minimize disruptions to production levels. [1] Nonetheless, the implementation of the asset revitalization program is likely to negatively impact shipment levels over the next few years. Concerns over the extent of the disruption is weighing on the company’s stock price. Our latest shipment estimate for the U.S. Flat-Rolled division represents a 20% decline in shipments by the end of our forecast period, as compared to our estimate before the company’s Q1 earnings release.

The sharp decline in U.S. Steel’s stock price may be somewhat of an overreaction by investors to the uncertainty surrounding the production levels of the Flat-Rolled division. If the company is indeed able to minimize the extent of the disruption to shipments over the next few years as promised, we could witness a sharp recovery in the stock price. Time will tell whether U.S. Steel can recover in time to benefit from the prevailing favorable business conditions in the steel industry.

Have more questions about U.S. Steel? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for U.S. Steel

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Notes:
  1. U.S. Steel’s Q1 2017 Q&A, U.S. Steel Website [↩] [↩]
  2. US issues final antidumping duties for hot-rolled coil steel from seven nations, Platts [↩]
  3. Trump plans executive order on steel imports, Politico [↩]
  4. U.S. Steel’s Q1 2017 Earnings Release, SEC [↩]
  5. Trump to unveil $1 trillion infrastructure plan in 2017: Official, CNBC [↩]
  6. U.S. Steel’s Q1 2017 Earnings Call Transcript, Seeking Alpha [↩] [↩]
  7. U.S. Steel’s Q3 2016 Earnings Release, SEC [↩]
  8. U.S. Steel’s Q4 2016 Earnings Release, SEC [↩]
  9. U.S. Steel’s Q1 2017 10-Q, SEC [↩] [↩]