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United States Steel (X) ended 2013 with a loss of $122 million in the final quarter, bringing its annual net loss to $2.06 billion. The net loss was largely due to a series of non-cash charges, such as goodwill impairment and restructuring charges, that amounted to $2.1 billion. In the fourth quarter, the company recorded a charge of $302 million related to the permanent closure of iron and steel operations at the Hamilton plant. These operations had remained idle since late 2010, and this closure will result in annual cost savings of $50 million going forward.

The closure is a part of U.S. Steel's cost cutting program, referred to as Carnegie Way, and should help in countering poor profitability. The company has failed to post an annual profit in the last five years. Under the program, the company aims to improve operational efficiency across four areas: raw materials, conversion costs, fixed costs, and revenue. Apart from closing down its steel making operations at Hamilton Works, the company also shut down two coke batteries at the Gary Works plant. These capital-intensive batteries were around 60 years old and were the most expensive to operate. As a result of these closures, the company will no longer incur operating costs and maintenance expenditures on these facilities in the future. Going forward, the company expects Carnegie Way to result in a savings of $150 million this year.

United States Steel is seeking permits to build an electric arc furnace to replace the existing blast furnace at the Fairfield Works facility. Compared to a blast furnace, an electric furnace produces steel in a more efficient and cheaper manner. An electric furnace uses steel scrap to produce steel, while a blast furnace consumes raw materials such as iron-ore and coke. Once operational, the electric furnace will help reduce the higher transportation and maintenance costs associated with a blast furnace. With a production capacity of 1.1 million net tons, the electric furnace could result in considerable cost savings. However, the electric furnace setup is subject to permissions, engineering studies, the approval of the board of directors, and wouldn't be completed until mid-2017. Hence, it will take some years before the company could achieve the cost benefits of using the new electric furnace.

U.S. Steel's rival, Nucor (NUE), has successfully maintained a low-cost structure with the use of electric furnaces. As a result, Nucor has posted annual profits consistently after posting a loss in 2009. Below, I have compared the operating margin of both the companies in the past three years.

Operating margin

2011

2012

2013

U.S. Steel

1.33%

1.28%

(10.9%)

Nucor

7.08%

5.22%

4.92%

In terms of operating margin, Nucor has consistently outperformed U.S. Steel. Although both companies have reported declining operating margins, Nucor has successfully operated at lower operating costs. However, I expect U.S. Steel's successful implementation of cost cutting measures and the use of an electric furnace will improve the company's operating margins in the coming years.

Will aluminum replace steel?

In 2012, transportation accounted for 16% of U.S. Steel's flat rolled steel shipments. The company's flat rolled segment, which accounted for 73.6% of its 2013 net sales, reported a revenue decline of 11.8% compared to the previous year. I expect the segment to experience growing competition from the use of aluminum in vehicles. Automobile manufacturers are under pressure to produce lighter vehicles to meet the corporate average fuel economy (CAFE) standards of 54.5 miles per gallon (MPG) by 2025. As a result, automobile companies are considering the use of aluminum in place of mild steel, which could reduce car weight in excess of 30%. Ford Motor (F) unveiled its aluminum made F-150 truck in the Detroit auto show last month. The new model consists of 97% aluminum and is 700 lbs lighter than the previous model. Owing to the lighter weight, the new F-150 is expected to push the truck's fuel efficiency to 30 mpg from an earlier 23 mpg. The F series truck has been the industry's top-selling truck for the past 37 years, and with Ford initiating the use of aluminum in its highly successful vehicle, the model's success could force other automakers to follow Ford's move.

By 2015, North American vehicles are expected to have four times more aluminum content compared to 2012. The U.S. aluminum sheet market is expected to reach 1 billion pounds this year from less than 200 million lbs in 2012. In the coming years, I expect the battle between aluminum and steel to intensify as auto manufacturers try to meet CAFE regulations. This might impact U.S. Steel's flat rolled segment performance negatively in the coming years. In 2013, the flat rolled segment's income from operations declined around 74%, and the rising demand for aluminum sheets from automobile manufacturers could further impact the segment's performance in the coming quarters.

Conclusion

U.S. Steel has been struggling with poor profitability, and it remains to be seen whether the company's cost cutting program will help it generate substantial cost savings. Moreover, the company's flat rolled segment, which provides steel to auto manufacturers, will be facing competition from the increasing use of aluminum in vehicles. Therefore, I recommend investors to hold their position and not make any new positions in this stock.

Source: U.S. Steel: Tough Road To Recovery