How Does US Steel’s Cost Of Sales Affect Its Total Expense Level And Profitability?

US Steel Corp’s (NYSE: X) total expenses have trended steadily higher from around $10.7 billion in 2016 to about $13.1 billion in 2018. As a percentage of revenues, expenses have decreased from 104% in 2016 to 92% in 2018. The company’s expenses are largely driven by cost of sales which accounted for 94% of total expenses in 2018, whereas as a % of revenue it stood at 87%. Cost of sales as a % of revenue has continuously declined from 94% in 2016 to 87% in 2018, due to a rising revenue base, increasing volume sold, and higher price realization per ton, which decreased cost of production per ton. This decline has added close to $970 million to the company’s profits (i.e. cost would have been higher by $970 million if cost of sales would have remained around 94% of revenues in 2018 as well). However, with cost of sales expected to go up again to about 91.5% of revenues in 2020, it would amount to the company’s bottom line being dented by about $600 million between 2018 and 2020.

In our interactive dashboard How Does US Steel Spend Its Money? we discuss the key drivers of the company’s expenses and net margins.

Total expenses

US Steel’s total expenses have increased from $10.7 billion in 2016 to about $13.1 billion in 2018. For 2019, we expect total expenses to stand at $12.7 billion, which comprises of-

• Cost of Sales: $11.8 billion
• Operating Expenses: $714 million
• Non-Operating Expense (Income): $301 million
• Income Taxes: -$170 million

Breakdown of US Steel’s Total Expenses

Cost of Sales

• Cost of sales has continuously increased from $9.6 billion in 2016 to $12.3 billion in 2018, driven by higher shipments.
• As a % of revenue, cost of sales declined from 94% to 87% during the same period, due to higher production and faster rise in revenues.
• However, cost of sales is expected to rise to 91%-92% of revenues in the near term as revenue is expected to drop due to decreasing steel prices, whereas raw material (iron ore) prices still remain high.

Selling, General & Administrative (SG&A)

• SG&A expenses have steadily increased from $306 million in 2016 to $336 million in 2018, due to higher compensation costs.
• As a % of revenue, it has continuously decreased due to faster growth in the top line.
• However, despite the cost expected to go down, decline in revenue is likely to lead to SG&A as a % of revenue to marginally rise to 2.5%

Depreciation and Amortization (D&A)

• D&A has continuously declined from 4.9% of revenues in 2016 to 3.7% in 2018.
• This is expected to go only marginally down to 3.5% by 2020, as the company would still be incurring capex on the Great Lakes facility and idling of the ECT operations and Dearborn, Michigan finishing facility.

Non-Operating Expenses

• US Steel’s Non-Operating expenses increased from $215 million in 2016 to $368 million in 2017, due to higher pension and other financial cost, followed by a decline to $312 million in 2018 due to decline in interest outgo and lower financial costs compared to the previous year.
• Non-operating expenses are expected to decrease further in the near term as interest cost declines on the back of lower interest rates.

Taxes

• US Steel’s Income Tax Expense has decreased sharply from $24 million in 2016 to -$303 million in 2018, due to reversal of a portion of the valuation allowance recorded against the Company’s net domestic deferred tax asset.
• Effective Tax rate decreased sharply from 5.8% in 2016 to -37.3% in 2018.
• The company is expected to record tax benefits in the near term, with the effective tax rate expected to hover around 20%-25%.

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