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WIKI ANALYSIS
The United States Steel Corporation (NYSE: X) is the largest integrated steel manufacturer in North America. The economic downturn broke the durable market along with demand for steel in the first two quarters of 2009, which interrupted U.S. Steel's record 2008 performance.
The company has three primary operating segments: flat rolled; tubular products (which make up the primary domestic operations of the company); and U.S. Steel Europe. The domestic operations of U.S. Steel are vertically integrated, meaning that iron ore and coke, which are the primary raw materials used to create steel, are supplied by the company itself. Currently, there are over 850 million tons of iron ore at the company’s Minnesota reserve, enough to supply domestic operations for 30 years.[1] Integration helps to insulate the company from the price volatility of iron ore and coke and therefore enables the company to operate at lower costs than non-integrated producers. U.S. Steel is hoping to begin integrating its services in Europe as well, although currently US Steel Europe purchases most of its raw materials from independent suppliers.
While US Steel was founded as a steel producer, it expanded and acquired several different business sectors over the 20th century. By the 1980's, U.S. Steel had a very diversified business structure that included involvement in the steel, energy, agri-chemical, domestic transportation and raw materials industries. Since then, however, the company has restructured itself and returned to its roots as a company dedicated to the production of steel products.In a currently consolidating steel industry, U.S. Steel has maintained discipline in its business approach in recent years, focusing on increasing the production of its current business sectors and improving its product quality. This conservative business approach is aimed to keep the company from suffering losses in times of industry setbacks or economic downturns. On the other hand, U.S. Steel may be missing opportunities to expand its business through acquisitions similar to the strategies employed by U.S. market leaders Arcelor Mittal (MT) and Nucor (NUE).
U.S. Steel still remains dependent on key industries and regions in spite of its vertical integration efforts. In particular, U.S. Steel is dependent on the petroleum and auto industries and is highly affected by activities in China, which affect most steelmakers worldwide.
- Oil and gas companies purchase nearly all of its tubular steel products for use on pipelines and oil rigs. The company is the market leader in this type of steel production and sources a third of its revenue from this sector.
- Automobile manufacturers consume 20% of all steel shipments to build cars and trucks. U.S. Steel is highly tied to the Big Three automakers (GM, Ford, Daimler Chrysler) which have suffered poor performance recently.
- While China is driving a large portion of the increase in demand for steel, the country is also ramping up its own steel production capabilities. China's becoming a net exporter of steel could flood the market and drive down prices.
Company Description
Despite record profits in 2008 (up 140% from 2007), U.S. Steel has seen reveresed fortunes in Q1-Q2 2009, with negative net income and net sales down 80% or more in each of its operating segments relative to the prior year. The collapse of the durables market ranging from the U.S. Housing Market Losses have been exacerbated by write-downs in the company's sizeable pension plan due to lower expected future equity returns. Losses have been mitigated 2-3% by the weakening of the US dollar, which makes U.S. Steel more competitive.[2]
Despite selling 60% less steel, the company's prices have stayed relatively steady. Keeping prices high despite low demand is typical of industries with large Economies of scale, relatively few players, and the presence of collusion (look for regular SEC antitrust cases). Fertilizer Companies, Steel companies, Precious Metals companies and other commodity businesses tend to exhibit this behavior.[2]
The U.S. Steel Corporation has three primary operating segments: tubular, flat-rolled, and european. "European" is not any particular kind of steel, it is just a combination of tubular and flat-rolled steel that U.S. Steel sells in Europe.
Flat Rolled Products
This is a domestic sector that includes the company's sheet, tin mill, strip mill and coke operations. Products from this sector include sheet metal that is used in cars, household appliances and construction projects. U.S. Steel has a flat rolled domestic production capacity of 19.4 million tons among five major sites around the United States. The steel produced in these operations is used to make truck frames, automotive wheels, shelving, doors, boilers and rail cars.[2]
Tubular Products
With a 21% market share, U.S. Steel maintains the top position in North America for tubular steel products. The company makes both seamless and electric resistance welded pipes that are used in oil and gas exploration and production projects and other forms of construction. About 80-90% of tubular products are supplied to the oil, gas and petrochemical industry. Tubular steel products include oil and gas drill pipes, steel casing and tubing as well as pipelines for oil, water and gas.
United States Steel Europe
U.S. Steel has two integrated steel mills in Slovakia and Serbia. Combined, these two mills have a production capacity of 7.4 million tons. European operations produce both flat rolled and tubular products.
Below is a breakdown of the three major operating segments of U.S. Steel and the amount of steel products each supplies to certain major end markets:
2008 Breakdown
| Flat Rolled | USSE | Tubular | Total | |||
|---|---|---|---|---|---|---|
| Sales (thousands of tons) | Sales (thousands of tons) | Sales (thousands of tons) | (thousands of tons) | |||
| Steel Service Centers | 3,871 | 1,239 | 16 | 5,126 | ||
| Further Conversion | 5,138 | 546 | 34 | 5,718 | ||
| Transportation | 2,550 | 590 | 8 | 3,148 | ||
| Construction | 1,333 | 1,745 | - | 3,078 | ||
| Containers | 1,421 | 615 | - | 2,036 | ||
| Appliances and Electrical Equipment | 1,115 | 503 | - | 1,618 | ||
| Oil, Gas and Petrochemicals | - | 9 | 1,737 | 1,746 | ||
| Exports from U.S. | 808 | - | 118 | 926 | ||
| Other | 609 | 404 | 39 | 1,052 | ||
| Totals | 16,845 | 5,651 | 1,952 | 24,448 | ||
The Steel Industry
Business Approach
The Steel Industry has entered into a consolidating phase since 2001. The 5 largest steel companies in the world have grown through acquisitions to represent a combined 20%+ global market share for steel products. U.S. Steel has taken a conservative approach to growth, instead focusing on improving its current product quality instead of trying to expand the breadth of its operations. In a reflection of this strategy, on March 29, 2007, U.S. Steel announced the $2.1 billion acquisition of Lone Star Technologies (LSS), a company whose principal operations are in the tubular sector. This acquisition is aimed to expand and improve U.S. Steel’s top market share on tubular products in the U.S. (21%).
Vertical integration has become a major strategy employed by U.S. Steel. The company has undertaken projects such as the construction of new blast furnaces and the upgrade of existing steelmaking shops in an effort to improve its domestic operational infrastructure and improve its product quality. In pursuit of this goal, to assure a reliable supply of coke to fire the blast furnaces of the company's domestic mills, US Steel is currently constructing three coke processing facilities.[4]
A primary goal of vertical expansion in the company’s European operations is to integrate the company’s current steelmaking operations by acquiring a raw materials base. Such vertical integration limits the effects of exchange rate induced price increases in raw materials procured outside the U.S., a growing challenge for many manufacturing firms. Doing this would insulate its European operations from fluctuating market prices, as the company does in its domestic operations.
Steel Demand: Customers and End Markets
Steel consumption levels correlate with economic growth and expansion. When the global economy is expanding, there is a rise in demand for steel, putting upward pressure on steel prices. When economic growth slows down, steel prices tend to fall. Economic expansion usually means that the primary end markets of the steel industry are performing well. These end markets represent the customers to whom companies such as U.S. Steel sell their products. When steel end markets are performing well, they will buy more steel to make more of their own product. In recent years, China has contributed to a resurgence in the demand for steel. Alongside this, the rest of the global economy’s steady growth has provided a stable environment for the steel industry.
The Auto Industry
About 20% of the steel industry’s shipments are to Auto Makers. Several different types of steel products are used for automobiles including flat rolled sheet for auto bodies, bar products for suspension, drive shafts and axles as well as steel alloys for wheels and engine blocks. As time has gone by, the demand for steel has increased as the size of cars and trucks has increased. A shift to smaller, lighter, and more fuel efficient cars could reduce the demand for steel in the future. U.S. Steel has a lot of exposure to the auto industry, especially the Big Three automakers. Poor performance by these three companies could hurt U.S. Steel's revenues.
Construction
Construction projects represent about 15-20% of steel consumption. Steel is used in framing for building structures, bridges, metal building systems and pipes. Construction projects tend to rise when the economy is in an upswing. The continued infrastructure and construction boom in the developing world, especially China, has continued to drive strong demand for steel in spite of a sharp downturn in the US building industry during 2008.
Containers and Packaging
Steel is used to make cans for food, chemicals and aerosol spray. The packaging industry has begun to scale back its usage of steel by replacing packaging materials with plastics and other more flexible materials and by shrinking the amount of steel used to make cans.
Oil, Gas and Petrochemicals
Tubular steel products are used to build pipelines and rigs. Rising oil prices have spurred exploration and the construction of oil rigs which has helped to maintain demand for steel from this industry. A strong hurricane season that causes a lot of damage to the oil industry's infrastructure also increases the demand for the steel parts that are needed for repairs. Average North American oil rig counts have a strong correlation with U.S. Steel's tubular product shipments.
The company's leading 21% market share in tubular products makes performance in this sector vital; nearly one-third of revenues come from this business unit.
Foreign Imports
Foreign imports of steel can have adverse effects for domestic steel producing companies. If foreign steel imports increase, that means there is more domestic supply which puts downward pressure on steel prices. In the past few years, steel imports to the United States have risen to comprise 31% of the steel consumed in the country. Increasing foreign competition in the future could reduce market prices and demand in the U.S. However, throughout 2008 ocean freight rates increased considerably effectively making imported steel products more expensive.[6] In 2006, U.S. Steel only exported about 5% of its domestically produced steel, so a weakening of the U.S. market is a potentially serious problem for the company.
China’s Impact
Robust economic growth in China has contributed to a great increase in the demand for steel. This demand has helped fuel the global rise in steel prices. There is concern, however, about whether or not growth in China can sustain at its current blistering pace. In 2003, Chinese demand for imported steel peaked at 43 million metric tons, that number fell to 16 million in 2005. A fall in Chinese demand for imported steel, coupled with the country’s own increase in steel production could turn China into a net exporter of steel. While U.S. Steel only exports 4% of its domestic production, China becoming a net exporter could potentially flood the steel market, leading to overcapacity and downward price pressure for the entire industry.
Environmental Concerns
The steel production industry is extremely energy intensive and is a heavy producer of greenhouse gases (GHG's). Facing increasing concern about global warming and simultaneous rising demands for energy worldwide, there has been significant legislation that now affects the steel industry.
The House or Representatives passed a bill to curb U.S. greenhouse-gas emissions on June 26, 2009. This bill, called Cap and Trade, will hurt integrated steel mills at US Steel (X), ArcelorMittal (MT) and Mechel Steel Group OAO (MTL) the most because they kick out the most carbon dioxide.
Nucor (NUE) and the Commercial Metals Company (CMC) primarily re-melt scrap, which emits about 2/3 less carbon than competitors. Even though Nucor and other mini-mill users might gain competitve advantage relative to integrated steel players like U.S. Steel, the net effect of the Cap and Trade Bill will hurt all domestic steel players because it will incentivize production in countries without emissions caps like Brazil.[7]
U.S. Steel is very entrenched in the United States, and as an integrated steel player will likely see its already dangerously low sub-5% profit margin decline.
Business Costs
Labor Costs
Labor costs make up about 25% of U.S. Steel’s domestic costs. The majority of the 21,000 domestic employees of the company are covered by a collective bargaining agreement with the United Steel Workers of America. The current contract that exists between U.S. Steel and the USWA is due to expire in September of 2008. It is too early to tell how negotiations between the two will go, but labor costs over the past decade have risen along with the rise in average hourly wages over that same period of time.
Energy Costs
Coal is the primary energy source for the production of steel. U.S. Steel purchases all of the coal it uses from third party vendors. The company’s domestic operations require an estimated 10 million tons of coal alone at an estimated cost of $700 million. Because all of the coal purchased by U.S. Steel is at market price, the company is exposed to price fluctuations in coal due to mine accidents, transportation mishaps and other factors. U.S. Steel also requires natural gas for its production. The company has partially hedged its position on these gases to protect itself from price fluctuations. While increasing coal and natural gas prices raise company expenses, as of mid-2008 management's predictions that increases in steel prices would outpace the additional costs from these two inputs had proved correct.
Market Share
| Manufacturer | Crude Steel Production (Thousands of Tons) | Market Share[8] | YOY % Change in Production |
| US Steel[9] | 3,023 | .96% | -60% |
| Nucor[10] | 2,808 | .89% | -53% |
| SCHN[11] | 1,037 | .33% | -19% |
| Steel Dynamics[12] | 886 | 0.28% | -45% |
| AK Steel[13] | 740 | 0.23% | -57% |
| CMC[14] | 435 | 0.14% | -42% |
Competition
What separates U.S. Steel from domestic competition is its focus on maintaining an integrated business model and its exposure to the tubular products market. U.S. Steel's tubular production services the high performing oil and gas industry. While Nucor (NUE) and Arcelor Mittal (MT), the other two major steel producers in the United States, have been busy with several acquisitions for growth, U.S. Steel has maintained a conservative acquisition strategy. The integrated business model that U.S. Steel has maintained in the United States and is now striving to achieve in Europe will help protect the company from industry wide downturns that could devastate steel companies that are exposed to raw material price fluctuations.
Mittal Steel is the world's largest steel producer. Their growth through acquisitions over the years has made them into a company that will continue to impact the steel market.
| Total Global Steel Production | Total Sales | Cost of Sales | Operating Income | % Gross Margins | U.S. Steel Industry Market Share | ||
|---|---|---|---|---|---|---|---|
| (mmt) | (bil) | (bil) | (bil) | ||||
| United States Steel | 19.3 | $14.0 | $11.6 | $2.4 | 17% | 16% | |
| Nucor (NUE) | 18.4 | $12.7 | $10.1 | $2.6 | 20% | 21% | |
| Arcelor Mittal (MT) | 63.0 | $28.1 | $21.5 | $6.6 | 23% | 25% | |
Source: 2006 Company Reports
References
- ↑ US Steel 2008 Annual Report, page 151
- ↑ 2.0 2.1 2.2 2.3 10Q-2 2009
- ↑ US Steel 2008 Annual Report, page 11
- ↑ http://seekingalpha.com/article/87791-united-states-steel-corp-q2-2008-earnings-call?source=feed
- ↑ MEPS: Global Steel Prices
- ↑ http://seekingalpha.com/article/87791-united-states-steel-corp-q2-2008-earnings-call?source=feed
- ↑ of Reps Passes Cap and Trade
- ↑ Steel on the Net - World Steel Review, August 2009
- ↑ X, Q2 2009, 10-Q, Item 4, Page 58
- ↑ NUE, Q2 2009, 10-Q, Item 2, Page 19
- ↑ SCHN, Q3 2009, 10-Q, Item 2, Page 30
- ↑ AKS, Q2 2009, Quarterly Earnings Release
- ↑ AKS, Q2 2009, 10-Q, Item 2, Page 27
- ↑ CMC, Q2 2009, 10-Q, Item 2, Page 25
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