U.S. Steel Looks Set To Miss Out On The Resurgent Demand For Steel

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The past few weeks saw two major steel companies, U.S. Steel and ArcelorMittal, release their first quarter results. However, there was a stark contrast between the results of both of these companies, specifically their U.S.- based operations.  While ArcelorMittal’s NAFTA business division reported a 93% year-over-year increase in its operating income, U.S. Steel’s Flat-rolled division reported an operating loss in Q1 2017, which was soon followed by a change in leadership with the company’s CEO stepping down. [1] ArcelorMittal’s operations benefited from a considerable improvement in the business environment for steel companies in the U.S. whereas U.S. Steel was unable to profit from the same. U.S. Steel attributed its poor Q1 performance to a renewed focus on its asset revitalization program, which is aimed at boosting the reliability and operating efficiency of its U.S. operations. However, the implementation of the asset revitalization program could mean that U.S. Steel is unable to profit from the favorable prevailing business conditions as the company’s competitors make hay while the sun shines.

A Revival in Fortunes for the Steel Industry

The U.S. steel industry has been adversely impacted by competition from unfairly traded steel imports over the past few years. Imported steels sold at unfairly low prices adversely impacted both realized prices and shipments for domestic steel producers. Based on petitions from the domestic steel industry, the Department of Commerce imposed antidumping duties over the course of 2016 on steel imports from countries that it determined were indulging in unfair trade, including major sources of steel imports such as China and South Korea. Subsequently, as a result of weakening competition from unfairly traded imports, steel prices improved substantially, with U.S. Steel’s Flat-rolled division reporting an 18% year-over-year increase in realized prices in Q1 2017. [2] Our pricing forecast for the Flat-rolled division reflects the much-improved pricing environment.

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In addition, if the federal government is able to implement its legislative agenda, specifically its infrastructure plan and tax reform, the demand for steel and the business environment for steel companies could become even more favorable. However, U.S. Steel could be in danger of missing out on this opportunity.

Is U.S. Steel Missing Out?

U.S. Steel’s Flat-rolled division reported a 4% year-over-year decline in shipments in Q1 2017 as the implementation of the asset revitalization program forced the company to lower production levels. [2] However, the timing of the decision to vigorously pursue the asset revitalization program seems to be extremely inopportune. The company management has stated that the asset revitalization process would take three to four years to implement completely, which is likely to result into three to four years of subdued shipment volumes. [3] As steel is a cyclical industry, this could mean that the company misses out on the entire prevailing phase of rising demand for the commodity. While there isn’t a convincing reason for the company’s decision to undertake the upgrade of its facilities at this point in time, one can only speculate that the management has taken such a decision because it had no other choice, since otherwise it would have deferred the asset revitalization program in order to profit from prevailing business conditions. This would imply that the company’s facilities are plagued by long-standing reliability issues, which were perhaps also manifested in the unplanned production outage of Q3 2016, which lowered production volumes by 125,000 tons. [4]

Several successive years of unfavorable business conditions in recent times have prompted U.S. Steel to lower capital spending in order to conserve cash. U.S. Steel’s capital expenditure from 2013-2016 averaged roughly $426 million per annum, around 41% lower than in 2012. [5] The need to conserve cash flows perhaps prevented the company from investing adequately in the maintenance and upgrade of its facilities in recent years. At any rate, the company’s Q1 2017 disclosures about its asset revitalization program took market participants by surprise.

The question now is, can the company quickly turn its fortunes around to take advantage of the prevailing business conditions? This is a question which isn’t easy to answer since there isn’t a great deal of clarity about the extent of the company’s operational issues. However, given that these operational issues seem to be of a long-standing, structural nature, it does not seem likely that shipments would revert to normal levels anytime soon. As per the company’s own estimates, it could take three to four years to fully implement the asset revitalization program. Even if the company were to adhere to its stated schedule, we are still looking at a lost opportunity to substantially increase shipments in response to rising demand. Our latest shipment forecast for the U.S. Flat-rolled division reflects the moderating effect of the asset revitalization program.

Thus, U.S. Steel could be about to lose out on an opportunity to take advantage of the rising demand for steel, one that its competitors look set to profit from.

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. ArcelorMittal’s Q1 2017 Earnings Release, SEC []
  2. U.S. Steel’s Q1 2017 Earnings Release, SEC [] []
  3. U.S. Steel’s Q1 2017 Q&A, U.S. Steel Website []
  4. U.S. Steel’s Q3 2016 Earnings Release, SEC []
  5. U.S. Steel’s 2016 10-K, SEC []