Why The New CEO Is Unlikely To Transform U.S. Steel’s Fortunes Anytime Soon

May 16th, 2017 by Trefis Team
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United States Steel

U.S. Steel announced a change in top management last week, with Mario Longhi stepping down as CEO. [1] Mr. Longhi has been replaced by COO David Burritt as the next CEO of the company. Though Mr. Longhi stated that he retired in line with his plans for a five-year tenure at the company (which he recently completed), the abrupt nature of the announcement has raised questions about the motivation for the change in top management, particularly as it has come shortly after the announcement of the company’s unexpectedly poor performance in Q1 2017. [1] Thus, this abrupt change at the top has raised questions about what the future holds for U.S. Steel — can the company do any better under the new CEO?

A Disappointing Q1 Amid Favorable Business Conditions

U.S. Steel stunned investors with an underwhelming Q1 earnings release, reporting a net loss amid favorable business conditions, in stark contrast to other leading U.S. steelmakers which reported strong earnings results. The company’s stock price has taken a beating since the earnings release on April 26.

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X Stock Price Apr May 2017 1

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

Q1 2017 was characterized by rising domestic steel prices post the imposition of punitive tariffs on unfairly traded steel imports over the course of 2016 by U.S. trade authorities. Besides weakening competition from unfairly traded imports, President Trump’s planned $1 trillion overhaul of domestic infrastructure has raised the demand outlook for steel in the U.S. [2] In addition, a fillip to economic growth from the potential implementation of other items of the incumbent White House administration’s legislative agenda is likely to boost economic growth and the demand for steel. Thus, the company reported poor results just when things were looking up for steelmakers, after years of unfavorable business conditions.

What Plagues U.S. Steel?

The company attributed the unfavorable results to a renewed focus on its asset revitalization program, as it looks to boost the reliability and operational performance of its U.S. Flat-rolled facilities. Work pertaining to the upgrade of existing facilities disrupted shipments for the Flat-rolled division, which reported a 4% year-over-year decline in its Q1 shipments amid favorable market conditions. [3]

The Flat-rolled division has been dogged by operational problems in recent times, with an unplanned production outage in Q3 2016 lowering the division’s shipments by around 125,000 tons or nearly 5% of its quarterly shipments. [4] The company reported a 6% sequential decline in shipments in Q4 2016 as a result of maintenance-related downtime to address some of these operational challenges. [5] In addition, the accidental release of waste water from the company’s Midwest plant in Portage, Indiana, temporarily halted operations at the plant last month. [6] Finally, the asset revitalization program is expected to negatively impact the Flat-rolled division’s shipments by around 1 million tons in 2017. [7]

The company management stated that the asset revitalization program is expected to span 3-4 years, including 2017. [8] These statements indicate that operational problems run much deeper at U.S. Steel than the market anticipated. Mr. Longhi had initiated a business transformation initiative in 2013 known as ‘The Carnegie Way,’ which aimed at boosting the company’s operational efficiency and lowering costs. Though the initiative is set to generate $310 million worth of savings in 2017, clearly there is a long way to go, with the asset revitalization program set to continue over the next few years. [9] This suggests that the company will be unable to take full advantage of the favorable business conditions on the horizon as shipments will remain subdued amid the implementation of the asset revitalization program.

So, why are U.S. Steel’s facilities in such bad shape? The lack of clarity regarding the answer to this questions is part of the reason for the sharp decline in the company’s stock price. One possible answer is that the company was unable to invest enough to upgrade its facilities amid the unfavorable market conditions prevailing over the past few years, as the need to conserve cash flows led to a drastic reduction in capital spending. A case in point is the postponement in the construction of the company’s Fairfield Electric Arc Furnace facility, which was delayed as a result of unfavorable market conditions. [10] The company’s capital spending over the years 2013-2016 averaged roughly $426 million per year, around 41% lower than in 2012. [10] In order to support the asset revitalization program, the company’s announced a 32% hike to its capex guidance for 2017. [9] The company’s capital spending is expected to remain elevated over the next few years as a result of the asset revitalization program.The following chart illustrates our capital expenditure forecast.

What Does the New CEO Bring to the Table?

With U.S. Steel looking at a tough few years ahead, the new CEO will very much be in the spotlight. David Burritt served in senior finance executive roles at Caterpillar, where he worked for 32 years, prior to joining U.S. Steel as CFO in 2013. [11] Though a respected finance executive, Mr. Burritt arguably lacks operational experience in the steel industry. Nonetheless, Mr. Burritt has been a part of the top management at U.S. Steel for the past four years and should be well versed with the problems facing the company. However, as we’ve noted earlier on, U.S. Steel’s problems are of a structural nature and will require three to four years to fix, as per the company’s own estimates. Given the nature of the challenges facing the company, there seems to be little hope of a swift turnaround in fortunes under the new CEO. Thus, a quick fix seems unlikely and Mr. Burritt has a daunting task on his hands. Given the enormity of the task ahead, we hope that Mr. Burritt is up for the challenge.

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 Announces Retirement of Chief Executive Officer Mario Longhi, U.S. Steel Website [↩] [↩]
  2. Trump Begins to Map Out $1 Trillion Infrastructure Plan, Wall Street Journal [↩]
  3. U.S. Steel’s Q1 2017 Earnings Release, SEC [↩]
  4. U.S. Steel’s Q3 2016 Earnings Release, SEC [↩]
  5. U.S. Steel’s Q4 2016 Earnings Release, SEC [↩]
  6. U.S. Steel’s Q1 2017 10-Q, SEC [↩]
  7. U.S. Steel’s Q1 2017 Earnings Call Transcript, Seeking Alpha [↩]
  8. U.S. Steel’s Q1 2017 Q&A, U.S. Steel Website [↩]
  9. U.S. Steel’s Q1 2017 Earnings Presentation, U.S. Steel Website [↩] [↩]
  10. U.S. Steel’s 2016 10-K, SEC [↩] [↩]
  11. David Burritt Profile, Bloomberg [↩]