United States Steel Corporation (X) is one of the largest steel producers in the world and the largest integrated steel producer headquartered in North America. The company has three main reporting segments Flat-rolled Products, U.S. Steel Europe, and Tubular Products. In addition to the steelmaking assets, the company has iron ore and coke production facilities, rail and barge transportation operations, real estate and engineering and consulting services.
Although X is benefiting from a strong domestic demand from the auto sector, the company's high margin tubular segment remains challenged and will more than offset any benefit from a recovery in steel demand during 2013.
Auto Demand - The Positive
2013 SAAR is expected to be 15.5 to 16 million units, a significant increase from its 2012 estimated total of 14.5 million units. X has a considerable exposure to auto market and is expected to benefit from the increasing demand in this end-market. However, the growth in demand in 2013 is expected to slow down from 2012 level.
Cars and trucks in U.S. are, on average, the oldest the country has ever seen and the domestic auto industry is benefiting from consumers replacing these old cars and trucks. Ford (F), General Motors (GM), Chrysler Group all reported domestic December sales better than consensus estimates.
Tubular Segment - The Big Challenge
Oil Country Tubular Goods (OCTG) has been one of the most profitable sectors and the main engine of operating profits for US Steel since 2009. Tubular segment accounts for approximately 50% of U.S. Steel's operating profit, while accounting for a much lesser proportion of total shipments.
The US OCTG market moved from essentially balanced in 2011 to a surplus in 2012. In addition to domestic supply growth, increasing imports from particularly Korea shifted the market to surplus during 2012. Looking ahead, both domestic and global production have the potential to add meaningful capacity in the coming years, putting further pressure on prices and X's margins.
Steel Inventories and Shipments Update
According to MSCI, on a daily average basis, total U.S. service center shipments of carbon steel fell 7.7% Y/Y and 14.4% M/M to 2.6 million tons in December. By product category, flat rolled declined the most M/M by 16.5%, followed by bars (-12%), pipe/tube (-10.3%), and plate (-8.8%). On a year-over-year basis, carbon bars shipments declined the most with 16%, followed by carbon plates (-7.9%), and flat rolled (-7.5%). However, on a full-year basis, bars were the only category to have declined (-3.0%) while structural products posted the largest Y/Y gains of 4.2%. Total steel shipments, including stainless and carbon steel, declined 14.3% M/M and 7.5% Y/Y.
Steel inventories held at the service centers increased 2.4% Y/Y and 4.56% M/M to 8.5 million tons, marking the first sequential increase in absolute tons at service centers since August/July. Carbon steel inventories increased 4.5% M/M and 1.9% Y/Y. While flat rolled and plate inventories increased 7.4% and 2.8% M/M respectively, carbon bar and structural inventories actually declined M/M by 5.5% and 2.2% respectively. Bar inventories are at their lowest since May 2010, while structural inventories are the lowest in more than 20 years.
X reported better-than-expected fourth quarter results, driven by higher-than-expected profitability from the flat-rolled segment and increased domestic auto production.
X reported 4Q12 adjusted EPS of -$0.41, beating consensus estimate of -$0.75. The adjusted EPS excludes a $9 million ($0.06 per share), favorable settlement related to a supplier contract dispute. The company reported net loss of $50 million, compared with $211 million a year earlier. Sales declined 7% to $4.49 billion from $4.82 billion a year earlier.
The company reported total operating profit of $59 million, compared to loss of $43 million in the same period last year, and $171 million in 3Q12. Flat rolled profits declined to $11 million from $29 million in the previous quarter, due to lower prices and shipments. European segment's profits also fell but remained positive at $7 million (3Q12: $27 million), as shipments remained stable, and price and operating costs both declined. Tubular results also declined QoQ as less drilling activity resulted in shipments and prices decline.
U.S. Steel indicated that it expects 1Q13 results to be flat compared to 4Q12, implying a first quarter loss of $0.35 to $0.45 per share.
In the flat-rolled segment, X expects near-breakeven operating results in 1Q13. The company expects higher average spot prices and shipments in 1Q13; however, higher prices are expected to be offset by market-based contracts, which tend to lag the spot market. Operating costs are also expected to be higher QoQ in the flat-rolled segment.
European segment's results are expected to improve QoQ as shipments are expected to increase significantly. Tubular segment's results are also expected to improve in the next quarter, as operating costs decline and shipments improve QoQ. While realized prices are expected to decline QoQ, operating costs are also expected to decline due to reduced repairs and maintenance costs and improved operating efficiencies. However, improvement in both sectors is not expected to be material.
X is trading at a current P/E of -11.4 compared to the industry average of 29.4; it has a forward P/E of 8.7 and a PEG ratio of 0.1. Its price/book ratio of 0.8 and price/sales ratio of 0.2 are less than the industry averages of 1.3 and 0.3. On the other hand, Nucor (NUE) and Steel Dynamics (STLD) are trading at forward P/E of 13.1 and 10.2 respectively. AK Steel (AKS) has a forward P/E of -4.3. The fact that X is trading at cheap valuations compared to its peers and the industry averages is not reason enough to buy the stock at this time.
X's balance sheet is not looking strong either. It has a debt/assets ratio of 0.26, less than the industry average of 0.23. Its debt/equity ratio of 1.03 is also significantly higher than the industry average of 0.49. Its current ratio of 1.73 and EBITDA/interest ratio of 0.48 are both lower than the industry averages of 1.87 and 4.14 respectively. X has a debt/EBITDA ratio of 40.29, again significantly higher than the industry average of 2.8 only.
X is one of the most cyclical North American companies. Its performance largely depends on the health of the economy, and with the present state of economic recovery, the outlook remains disappointing for X. And any good news is largely offset by further softening in X's high-margin tubular segment, and only a modest recovery in X's European segment. Despite strong demand from automotive end-market, earnings of this high cost integrated steel producer is expected to remain challenged in the near future. Particularly, OCTG fundamentals continue to deteriorate as imports and rising domestic capacity is rapidly deteriorating prices. The historical high margin segment is expected to remain challenged as more domestic capacity is brought on line. X's balance sheet is not looking strong either; moreover, it has a disappointing return on equity and poor profit margins. In short, the company doesn't have much going in its favor, we have a sell rating on X. In the present environment, we prefer NUE and STLD among steelmakers; both companies are levered significantly to end-markets, which are showing continuous signs of improvements.
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