United States Steel: Thoughts On Q1 Earnings

Summary

• While beating estimates, United States Steel reported devastating quarterly results as COVID-19 hit the first quarter hard.
• The company focused on idling facilities and raising liquidity for what is likely an extended period of weakness and uncertainty.
• As I don't believe in a rapid V-shaped recovery, I am on the sidelines to buy cyclical exposure at lower prices.

This earnings season feels like a never-ending horror story. It's almost always the same: companies either beat or miss absolutely terrible expectations, report weakness across the board, and withdraw guidance after mentioning to raise as much liquidity as possible to withstand an economic force that's shaping up to be worse than the Great Financial Crisis. The Pittsburgh PA-based United States Steel Corporation (NYSE:X) reported much better earnings than expected while missing on sales. The company was hit by imploding economic growth as every segment saw significantly lower sales on top of falling steel prices. While management is unable to give full-year guidance, the focus has shifted to maintaining healthy liquidity levels and lower costs. While I was long going into the earnings call and sold before the stock went down again, I will be a buyer of more shares as soon as economic growth bottoms or as soon as the market gets serious hints that infrastructure stimulus is underway. I expect this will happen as soon as the market starts selling off again.

Source: United States Steel

Here's What Happened In Q1

Let's start by mentioning the good news first. US Steel reported earnings per share of -$0.73. While this is the fourth consecutive quarterly decline and third consecutive quarterly loss, it's well above estimates of -$0.84. Before I show you the quarterly details, keep in mind that earnings continue to perfectly follow economic momentum. In Q4 of 2018, economic leading indicators in the United States peaked, resulting in negative earnings growth in the second quarter of 2019 and beyond.

Source: Estimize

With this in mind, let's look at company-wide sales and segment performances. As I already briefly mentioned, weakness started all the way at the top as sales came in at $2.75 billion. This is down 21% compared to the prior-year quarter and below expectations of $2.80 billion. One reason sales were bad is the poor performance of the company's largest flat-rolled segment. While production inched up slightly less than 100 thousand tons, shipments fell by more than 200 thousand tons to 2.5 million tons (-7%). Flat-rolled prices fell by 10.9% to $711 per ton. The company's segment EBITDA took a dive as EBITDA came in at $86 million compared to $199 million in Q1 of 2019. EBITDA margin fell from 8% to 4%. The reasons for this weakness are much lower vehicle sales. Domestic light vehicle sales for the month of March were 11.37 million (SAAR) - this is a ten-year low. 2020 USMCA auto-build forecast is down 19% year-on-year. The packaging segment was up as higher consumption of tin products caused higher demand. Unfortunately, gains in this segment were easily offset by lower automotive and commercial sales.

US Steel Europe did even worse as EBITDA fell from $52 million in Q1 of 2019 to $9 million in Q1/2020. Commercial results pushed EBTIDA down $64 million due to 14% lower car production, 1.9% lower construction sales, and 11% lower appliances. This result was partially offset by a $25 million benefit from maintenance and outage.

Luckily, the company's tubular segment is its smallest as imploding oil prices hit this segment like a wrecking ball. Segment EBITDA fell from $21 million to -$35 million as shipments declined by 9.7% while prices declined by 17.2%.

COVID-19, Uncertainty & US Steel

The number one reason why I stopped using leading indicators in most of my articles is the fact that all eyes are on government policies regarding shelter in place measures. Once the economy is allowed to open up again, leading indicators will improve again. Unfortunately, it's not as easy as that. Opening up the economy will not result in a steep V-shaped economic recovery in my opinion. We are currently at a stage where the economy has entered structural weakness. While new weekly jobless claims have decelerated over the past 3 weeks, we are about to enter a new stage of weakness as industries that reported growth in March are now seeing severe weakness. The quote below is a comment from the fabricated metals industry from the latest ISM manufacturing report for the month of April.

"We supply the construction industry in various ways, where the slowdown has been a bit slower than most industries. It is, however; beginning to impact our business, and we see more challenges on the horizon."

This is a comment from the nonmetallic mineral products industry:

"COVID-19 has destroyed our market and our company. Without a full recovery very soon, and some assistance, I fear for our ability to continue operations."

As a result, US Steel has prepared for the worst. The company has idled 61% of its tubular segment and indefinitely closed all flat-rolled production facilities in the Great Lakes, as well as its Keetac iron ore pellets facility (and many more). Meanwhile, liquidity has been increased. Right now, cash and cash equivalents are valued at $1.35 million. This is up from $749 million at the end of 2019. As a result, the company's current ratio has increased from 1.45 at the end of 2019 to currently 1.69 - meaning that current assets cover 169% of current liabilities. Unfortunately, the company's restructuring has pushed net debt to a new multi-year high of $3.37 billion. This pushes the total debt/equity ratio up from 94.7% to 131.7% and net debt/EBITDA to 9.99. While all of this does not indicate bankruptcy as liquidity levels are satisfying, we are once again in an economic downturn with elevated debt levels. It won't kill the company, but leverage accelerates sell-offs as the stock is down 50% over the past 12 months.

Takeaway

The first quarter was better than expected but still a good example of the COVID-19 impact on the economy. While I was lucky to sell the stock at a small profit, I will be looking to buy US Steel lower as a longer-term investment. I do not expect a quick economic recovery. While stocks are 30% above their March lows, the economy keeps slowing. I expect stocks to show more weakness in the weeks and maybe months ahead. While I will stick to a few dividend stocks that I own, I will start buying cyclical stocks like US Steel as soon as leading economic indicators start improving again. While it will likely mean that I miss the perfect bottom opportunity, it will keep me from buying too much cyclical exposure in what could become a new sell-off.

Source: FINVIZ

My advice, therefore, is to keep an eye on the stock and to keep your exposure small if you decide to buy at current levels.

Be safe and stay tuned!

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