I like to keep a close eye on the developments of the steel industry and sometimes, I come across interesting investment options, like United States Steel Corporation (NYSE:X). Although I take many aspects into account when I analyze a company, in this article I will focus on debt and liabilities. Apart from looking into the company's total debt, total liabilities and debt ratios, I will examine what analysts and other top investors think about this company.
As the second largest Steel producer in the U.S., and with facilities in Canada and Slovakia, this company has over 30 million tons of steelmaking capacity. It also produced flat-rolled and tubular products for several end markets and applications, in addition to operating four iron ore mining sites. However, despite being 100% self-sufficient, this company operates in the highly fragment steel industry, where profits are attributed mostly to peers with low-cost production. This is not the case at all for U.S. Steel, making it very vulnerable to shifts in iron ore and steel prices, as well as general economic downturns.
Therefore, this debt analysis is crucial to understanding the risks of investing in the company, and will allow us to appreciate how leveraged it is, and what kind of returns to expect for a long-term investment. As the years 2008 and 2009 have taught us, leveraged companies with large amounts of debt can have a devastating impact over your investment. In fact, U.S. Steel's revenue dropped 53% in that time period. So, by taking a close look into the debt scheme of United States Steel, we will be able to elucidate if the company is likely to maintain its capital, and use it for future growth.
Total Debt to Total Assets Ratio
This metric is used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. A debt ratio greater than 1 indicates that a company has more total debt than assets, while a ratio below 1 states that the company has more assets than total debt. Used along with other measures of financial health, the total debt to total assets ratio can help investors determine a company's level of risk.
United States Steel's total debt to total assets ratio has increased over the past three years from 0.24 to 0.30, indicating that since 2010, the firm has added more total debt value than total assets, which is not a good sign for bond investors. However, given that the ratio is smaller than 1, the financial risk faced by this company is relatively low; its assets' value comfortably surpasses the total debt levels.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity and if the ratio is above 0.5, the company's assets are likely financed through debt. Companies with high debt/asset ratios could be in danger if creditors start to demand repayment of debt.
When looking at United States Steel's debt ratio over the past three years, we can see that it has diminished from 0.77 to 0.74, which is encouraging, as I usually like to see the debt side of a company's balance sheet shrink. Although the 2013 TTM numbers are above the 0.50 mark, indicating that the firm has financed most of its assets through debt, the decrease in this ratio shows that it is a less risky investment today than it was three years ago.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed. A high ratio generally means that a firm has been aggressive in financing its growth with debt, which can result in volatile earnings. It also indicates that a company is unable to generate enough cash to satisfy its debt obligations, therefore making it a riskier investment.
United States Steel's debt-to-equity ratio has fallen over the past three years, marking 2.92 in 2013, compared to 2011's reported 3.58. This is an encouraging sign, as it shows that the company has ameliorated its balance sheet and risk profile. Nevertheless, the company's ratio of 2.92 - which surpasses 1x - implies that the company still faces high risks, and so do their investors.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells investors the extent to which the company is using its equity to support operations and growth, thereby helping in the assessment of risk. Companies with a high capitalization ratio are considered to be risky: if they fail to repay their debt on time, jeopardy of insolvency is bound to escalate, making it more difficult to get loans in the future.
Between 2011 and 2013, United States Steel's capitalization ratio has grown slightly, from 0.51 to 0.52. This means that the company has reduced its equity levels in relation to its long-term debt, and thus, has less equity to support its operations and growth. The current ratio (0.52) also indicates moderate financial risk.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt, indicating a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions.
As the United States Steel's ratio currently stands below 1, the company lacks the ability to cover its total debt with its yearly cash flow from operations, which is most certainly not ideal for an investment.
I also evaluate recent institutional activity in the stock. In other words, which hedge funds bought or sold the stock. In the most recent quarter, both Paul Tudor Jones and Chris Davis, among other prominent investors, sold out their shares of United States Steel, at an average price of $25.51. This leads me to believe that the company may not be looking at profits for some time.
Analysts expect United States Steel Corporation to deliver mediocre performance over the upcoming years. Analysts at Yahoo! Finance expect United States Steel Corporation to retrieve EPS of $1.64 for the current fiscal year and an EPS of $2.26 for the next fiscal year. In addition, they project revenue will reach $18.00B for the current fiscal year and $18.19B for the next one. Moreover, on February, two major research firms, KeyBanc and Citi, downgraded United States Steel Corporation to "hold" and "sell" recommendations, respectively.
As this analysis has shown, U.S. Steel is definitely not the safest investment, especially not in the long term. The company's dependency on global commodity prices, as well as its lack of technological innovation regarding blast furnaces (which require higher maintenance costs and repair time than competitors' electric arc furnaces), are strong concerns.
Moreover, the lack of significant cash flow over several years subjects the firm to higher financial leverage, therefore making it vulnerable to any strong economic headwinds. The all-round negative results regarding operating margins, net margins, returns on assets, and revenue growth make me feel bearish about U.S. Steel's long-term future. Therefore, I recommend investors stay away from this company and look towards other industry competitors for a safer and more profitable investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.