U.S. Steel will announce its fourth quarter earnings on Tuesday, January 28. We expect the company to report no significant growth in profits, if any. This is because while the pricing environment for steel was slightly better in the fourth quarter, we expect lower shipments year-over-year. The results for the first nine months in 2013 showed a 5% drop for flat-rolled steel and a 9% for tubular steel sales by volume, and we expect the company to have fared no better in the fourth quarter on this front.
While the U.S. Steel stock price surged in late December and early January, it has subsequently undergone a significant correction. We think that the rally was driven by a surge of positive sentiment due to lower expected raw material prices, the expected cost reductions from Project Carnegie and expectations of strong economic growth in the U.S. going forward. However, in our view, the structural factors in the industry remain unchanged and challenges remain the same as before. Therefore, there seem to be no material positive triggers on the horizon at the moment.
Challenges In Tubular Steel Continue
The rising tide of imports into the U.S. has prompted U.S. Steel and other major producers to ask for duties on imported oil and tubular country goods 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. 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. However, the probe is likely to take time to complete and the company’s tubular steel business is likely to continue facing challenging business conditions in the meantime.
Irrespective of the present status of the case, we expect the performance of the tubular steel segment to have been negatively impacted in the fourth quarter. In addition to imports, other factors such as increased market supply by domestic producers, announcements by other companies of further capacity addition and the ability of oil and gas companies to function better with lower number of rigs will contribute negatively to this division’s performance. In the third quarter, these factors had forced U.S. Steel to record an impairment of $0.8 billion at its Texas plant which produces tubular steel. Also, oil and gas companies typically spend less in the fourth quarter as they attempt to remain within budgeted annual capital expenditure.
Impact Of Other Factors
U.S. Steel has been placing a lot of faith in its Project Carnegie initiative to make its operations more efficient and reduce costs across the board. The savings are expected to be worth $75 million this year which we think won’t impact profitability significantly this year. The gains may get compounded over the next few years but until then, we don’t see this as a material factor impacting profitability.
China’s steel production capacity has reached about 800 million tonnes this year which is negative for prices. While the government is now belatedly attempting to cut down this capacity by shutting down polluting units and the availability of credit has somewhat tightened, we will have to wait and watch how the situation unfolds over the next few quarters.
There are other positives going for the company in the forthcoming quarters. These include lower coke prices, self-reliance for iron ore and replacement of coke by natural gas at some plants. However, these won’t confer an advantage over rivals if iron ore prices in global markets decline as is being expected in anticipation of a supply glut and if the permission to export liquefied natural gas on a large scale leads to higher gas prices. Even if natural gas prices remain low, any short-term advantage is likely to be negated by rivals adapting their operations to use gas instead of coke.
In the earnings conference call, we would like to hear a status update in the ongoing case against steel imports, the management’s strategy to deal with a likely shift to aluminum by automotive manufacturers and the expected cost savings from Project Carnegie next year and beyond.
We have a price estimate of $19 for U.S. Steel, which represents a 25% downside to the current market price.
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Source: Forbes Business