U.S. Steel (X): Will It Return to Profitability Soon?

U.S. Steel’s flat-rolled products segment generated 73.7% of the company’s total revenue in the first nine months of 2013. In North America, the construction and automotive industries account for more than half of the flat-rolled products consumption, and in 2013 demand has been strong for automobile manufacturers. In the first nine months, the U.S. and Canada together reported annualized car sales of 17.23 million, an increase of 7.2% year-over-year. This is in line with the forecast growth of 7% in 2013 for the overall North American automobile market.

Around 25% to 30% of the car’s weight consists of its metal body, which is known as body in white, or BIW. The BIW consists of various components in which design is based on several factors such as durability, formability, appearance, and cost. For these automobile components, U.S. Steel produces steel under four categories — low-carbon, high-strength, dent-resistant, and advanced high-strength steels (AHSS_. Out of these four, AHSS in particular benefits automobiles, as it is a substitute to mild steel mainly because it reduces car weight.

Lighter vehicles: Good for steel companies only?

Since 1990, greenhouse gas emissions from transportation have increased by 18%, leading to stricter emission regulations in the U.S. Moreover, the corporate average fuel economy, or cafe, standards have become more stringent. By 2025, it will be mandatory for an average car to achieve 54.5 miles per gallon. To lower carbon-dioxide emissions and improve fuel efficiency, automobile manufacturers are being forced to produce lighter vehicles. As a result, use of regular steel to produce vehicles has been lessening, strengthening the case for AHSS. With AHSS, automobile manufacturers can design parts that are up to one-third lighter, without affecting collision safety.

The $400 million joint venture of U.S. Steel and Kobe Steel (KBSTF), PRO-TEC Coating, started the commercial production of AHSS from its continuous annealing line in May. The continuous annealing line can produce 500,000 tons annually, and this capacity will help U.S. Steel capitalize on AHSS demand by U.S. and Japanese car makers. However, steel companies are generally in for some competition as other materials such as aluminum and plastics are also replacing conventional steel.

Aluminum products, meanwhile, are supplied by companies such as Alcoa (AA), which expects to increase its aluminum sheet sales to automobile makers from $160 million in 2012 to $580 million by 2015. Use of aluminum in place of steel improves fuel efficiency as a 10% reduction in weight leads to fuel savings of 5% to 7%. Currently, aluminum is mainly used in engine blocks, heat exchangers, transmissions, and wheels. For doors, bonnets, and wings, however, aluminum has little presence.

When AHSS and aluminum are compared in terms of cost, AHSS is a better replacement for regular steel. Even though aluminum will help make a car lighter, it will increase production cost by more than 50% compared to AHSS. Moreover, AHSS will help to reduce weight by 25% to 30%, slightly lower than weight reduction from using aluminum’s.

Further, an average vehicle is expected to get lighter by 400 pounds by 2025. The following forecast displays that car weight reduction will be led by the increased use of AHSS, with aluminum hardly making inroads. Even though these projections look promising for AHSS producers, can U.S. Steel capitalize on this opportunity?

Profitability: A big concern

U.S. Steel’s past income statements reveal it has been unable to report a net profit in the past four fiscal years. On a trailing 12 months, or TTM, basis, the company posted a net loss.

U.S. Steel 2009 2010 2011 2012 TTM

Net income (in $ million) (1401) (482) (53) (124) (1992)

The company’s TTM loss, however, is largely due to the goodwill impairment charge of $1.8 billion that it recorded in the third quarter from the Stelco and Lone Star Technologies acquisitions in 2007.

One of the company’s competitors, AK Steel Holding (AKS), has also struggled with profitability. The company reported annual losses since 2009 and is struggling on a TTM basis, too.

AK Steel 2009 2010 2011 2012 TTM

Net income (in $ million) (75) (129) (156) (1027) (312)

Will Project Carnegie lead to better profitability?

Under its new management team, U.S. Steel initiated a cost-cutting program termed as Project Carnegie to improve profitability. The company’s cost-cutting should save $75 million per year. It has already announced it will close its Hamilton Works plant on Dec 31, 2013, and expects the closure to reduce annual costs by $50 million. However, the Hamilton closure will result in an asset write-down of $225 million in the fourth quarter. Also, the company ceased operations at two of its highest-cost coke batteries at Gary Works. These closures should not only result in operating cost savings but also eliminate future maintenance expenses and capital spending.

Conclusion

The growing automobile market will provide opportunities to steel makers. Stricter emission regulations should increase demand for AHSS. Even though U.S. Steel has performed poorly in generating profits, the new management team must be given time to see whether it will execute Project Carnegie successfully.

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