Several onths ago, I speculated about the possibility that a trade case would be filed with the International Trade Commission (ITC) against foreign sources of oil country tubular goods (OCTG). Yesterday, reports surfaced that the trade case was finally filed. Originally I had speculated that it would just be against South Korean manufactures of OCTG pipe, but instead the industry took a much more aggressive move, filing against nine countries in total: India, South Korea, Philippines, Saudi Arabia, Taiwan, Thailand, Turkey, the Ukraine, and Vietnam. There are really only two stocks that have a large amount of exposure to domestic OCTG pipe manufacturing solely in the United States: U.S. Steel (X) and Northwest Pipe (NWPX). What could this trade case mean in absolute dollars to these two companies' fortunes?
The OCTG pipe market in the United States is a unique one in the steel business, as it is the only market that historically has had as much as 50% of total demand satisfied by foreign imports. The other steel markets can normally be fully supplied by domestic production, except during periods of heightened demand activity. Pipe manufacturers' returns have always been very cyclical, but the degree to which imports affect the market likely increases the sensitivity of company returns to changes in aggregate supply. How can we estimate what the impact could be to pricing and profitability? Luckily there was a significant trade case on OCTG filed in 2009 against China. We can use this as a test case for what might happen in this situation.
In mid-2009, the U.S. filed a similar trade case regarding OCTG pipe against China. By early 2010, the ITC found in favor of the U.S. complaint that allowed the U.S. to levy tariffs on Chinese OCTG pipe products. The result was a reduction in total Chinese imports by greater then (40%) in 2010. Unfortunately, the government data doesn't break out each country's activity by product, but we can assume by the total figure for China that OCTG pipe probably came to a complete halt during this period. This had a meaningful impact on U.S. manufacturers' profitability, but other countries picked up some of the supply slack that occurred from China's forced exit. There was some speculation in the industry that China was circumnavigating the restrictions by shipping pipe through other countries first not affected by the tariffs. For example, while China's total steel tonnage declined by (41.3%) in 2010 vs. 2009, South Korea's increased by 54.3% at the same time.
U.S. Imports for Consumption of Steel Products NSA
Total Steel Quantity in Tons:
Year over Year %:
OCTG Quantity in Tons:
Year over Year %:
China Quantity in Tons:
Year over Year %:
Korea Quantity in Tons:
Year over Year %:
It's hard to know for certain if these industry suspicions are correct from the numbers alone, as the global and domestic economies were strengthening during that time period. However, it does appear by yesterday's trade case filing that the industry believes it was a factor. Listing nine different countries in the filing is a noticeable change. Including countries like Saudi Arabia and Taiwan is also significant, as both have been suspected in the past of laundering tariffed steel products from other nations. Six of the nine countries listed in the complaint were responsible for over 20% of total tons imported into the U.S. in May of this year. The other three are not even broken out by the government data, which might be another signal that the industry suspects them as likely alternative routes for delivering steel products.
U.S. Steel is the only public example that we have to look at of a domestic manufacturer of OCTG pipe at the time that the trade case was filed against China. NWPX's tubular products segment was a fraction of its current size and impact at that time. I don't believe Tenaris SA (TS) is as good a company to look at in this case, because it is such a large global manufacturer of OCTG pipe that swings in U.S. profitability don't have as clear of an impact on their total financials. Less than 50% of total sales in tubes were in North America in 2010.
U.S. Steel, however, has a dedicated domestic segment for OCTG product. It was acquired mostly through the acquisition of Lone Star Steel (LSS) in 2007. Looking at the data from X's OCTG segment from 2009-10, it must be remembered that the domestic economy was emerging from a severe economic contraction. However, it is apparent that the timing of the filing led to an immediate improvement of this segment's profitability. When the ITC found in favor of the U.S. complaint later in 2010, then another significant level of improvement occurred as profitability per ton more than doubled.
U.S. Steel's Tubular Segment Quarterly Data
EBIT / Ton
ASP / Ton:
Ship in Tons:
Tube Seg EBIT:
Over the last five quarters, U.S. Steel had produced EBIT from the tubular segment of $129, $103, $102, $32, and $64 last quarter. They should see some improvement in the third quarter based off of this filing. If the complaint succeeds, then there will likely be another material leg up in profitability. Generally speaking, the tubular segment has been the only consistent source of profits for the company in recent years. If their segment EBIT bumps back up to 100 in the second half of this year, then total company EBIT would improve by about 36 million vs. what they did in the first quarter. That would have equated to about 74 million in total company EBIT.
That may be enough to swing the company back into profitability if they don't have a pension contribution to make, but it's not going to turn the company into a money machine alone. Even with the benefit of the trade case in 2010 U.S. Steel didn't turn a profit. The stock trades for well over 2x tangible book value, and has material leverage and pension risk attached to the equity. They will get a benefit, but the actual net earnings and cash flow improvements are also dependent upon the other steel products reducing their losses.
NWPX has been a company in transformation recently. They have a tubular segment making OCTG and line pipe that has materially expanded capacity in recent years. In 2010 the company's capacity was only 150,000 tons. It is currently about 425,000 tons and will likely by 500,000 tons by the end of this year. New management has been running the company for the last two years, and the significant operational improvements they have made have already been manifest in the record-breaking EBIT and margins that the Water Transmission segment recently produced in the last two quarters. NWPX has historically produced a lower quality mix of pipe vs. U.S. Steel's segment, but management has been using capital to improve the product offering and narrow that gap. Historically, NWPX has maxed out at about 40% of X's EBIT/Ton profitability level.
If we assume that relationship holds, (which I think is likely way too conservative), and we assume X can get its EBIT/ton figure back to $140 sometime next year, then NWPX's tubular segment alone would produce over a $1 in EPS on an annualized run rate. Over the last three quarters the segment has produced essentially zero EBIT. The current street estimate for 2013 is $1.59, which assumes no benefit from improvement in the tubular segment. The stock has tangible book value support at $26.19, and net debt to EBITDA is less than 1x on last quarter's report. As recently as a month ago, management guided total EBITDA to double from 2011 by 2015. That would imply about $5 in EPS. With this trade case, that may come to fruition much sooner than expected.