U.S. Steel (X) announced 4th Quarter earnings Tuesday with a huge positive surprise. They reported diluted earnings per share (DEPS) of $2.65. They beat estimates by over $1.20 per share. My own calculations also show Operation Cash Flows (CFOs) of $327 million (2.81 per share) and Free Cash Flows of $64 million ($0.55 per share). Things look fairly solid on the face of it. Naturally, one expects next fiscal year to be a downer comparatively speaking, but so long as US Steel can limit their losses, they should fare well.
Despite this, I find myself a bit worried about one aspect of their recent release. Call it the “other earnings surprise” if you will and it comes on the balance sheet. I tend to keep a close eye on assets, liabilities, and stockholders’ equity (SE). While glancing through U.S. Steel’s 4th Quarter financials, I noticed that SE dropped from $6.18 billion on their 3rd Quarter balance sheet (or $52 per share) down to $4.9 billion on their most recent balance sheet (or $42.35 per share). That seems like quite a precipitous drop, especially after a profitable quarter with positive FCFs.
This drop seems to be explained largely by two line items:
- Accounts receivables decreased by about $1 billion. This is not all that surprising given the downturn in the steel industry and should also be reflected in X's cash flows.
- Employee benefits increased by $1.2 billion to $4.8 billion.
Also, it's worth noting that X's Goodwill actually increased by about $150 million so that does not explain any of the drop; in fact, it makes the drop more confounding.
Of my two causes, the latter is by far the more important one. It is mentioned in the earnings announcement that U.S. Steel needs to increase pension expense by about $100 million due to 2008 asset performance (not surprising given the destruction of equities around the globe!). X also mentions that their pension is underfunded by $2 billion on an accounting basis and other benefit plans were underfunded by about $3.1 billion.
I am unsure how to feel about this. I still like US Steel long-term, but it's amazing to me how dramatically accounts can shift from one financial statement to another. Theoretically, you'd expect X's equity account to increase after a highly profitable quarter with positive FCFs, but apparently, pension liabilities have bit them hard.
US Steel can still be a good buy (in my opinion) under $35, but I do find myself admittedly somewhat concerned over this amazing drop in equity. It reminds you just how fleeting and malleable accounts can be under our accounting standards and it’s certainly something to keep an eye on for current X shareholders and anyone thinking of buying into U.S. Steel.