Where should 'X' mark the spot?
After Q4 print of -$1.86 and Q1 2010 guidance inline with Q4, U.S. Steel's (NYSE:X) share price has faltered. As of Friday's close, it is holding at $44.50.
Has the bleeding stopped?
Here are five reasons why X will ultimately bottom out, near term, closer to current BV than its current range of 1.4-1.5x BV.
U.S. Steel has to fund $530 million of capex in 2010. This amount is scheduled to increase again in 2011 and 2012 by around $200 million. This will bleed the current cash on hand down from $1.2 billion to $670 million or roughly $4 per share. 2010 depreciation is estimated to be $670 million. This will haircut tangible assets by another $1 per share after the benefits to the PP&E account from capex.
2) Working Capital
U.S. Steel largely funded its 2009 operating losses by bleeding down its working capital/inventory account. As of the end of Q3, inventory sits at around 45 days worth of sales. Further operating losses will likely be financed by cash on hand, adding further pressure to X balance sheet.
3) Pension Liabilities
U.S. Steel's unfunded pension liabilities currently stand at $2.9 billion with a 2010 funding requirement of at least $500 million. These funds are used to finance the requirements of X's 130,000 retired employees. X's competitive set in many cases does not have this pension expense...leaving X in much the same boat as the auto industry pre-restructuring - simply unable to compete with lower cost outfits.
4) Expiration of Cash for Clunkers
The auto industry is a large end market for X's flat rolled product. Cash for Clunkers pulled demand forward. The potential for soft auto sales into back half of 2010 could keep X operating at a loss for the entire year.
5) Debt Downgrade
Fitch downgraded X's debt to junk status. This has the effect of raising its cost of capital into the future. Already, management has indicated that it will likely have to raise additional funds to finance capex beyond 2010. This will have to be dilutive to existing shareholders.
Adding together these effects, X's book value per share is only heading in one direction, and that continues to be south. From a Q4 level of around $33 per share, by the end of Q1, BV should already head below $30 if one includes $1.50 in operating losses and the obvious effects on cash on hand from scheduled capex.
If the steel cycle doesn't turn by the summer, book value will continue lower into the $20s...taking tangible book value well into the low teens along with it.
Investors buying U.S. Steel here are paying 1.5x unadjusted BV or 2.4x tangible BV for a cyclical that continues to bleed cash, has significant structural issues with its pension liabilities, and has reduced funding flexibility going forward.
Already in 2009, X has given convertible debt holders the right to dilute existing common shareholders to the tune of 27 million shares at a price of $31.875.
This conversion price seems like a logical, near term floor for X absent near term visibility for capacity utilization levels that will, at the very least, see it stop leaking book value all over the road.
1.5x BV is just too rich for a company facing such a tough road ahead, including the potential for a double-dip recession.
X is still a short.
Target Price - $30.
Disclosure: Author holds a short position in X