U.S. Steel: Cost-Cutting Helps, But Headwinds Persist
United States Steel Corp (NYSE:X), the largest U.S. producer of steel by volume, is taking a number of actions to cut its costs and to manage macroeconomic headwinds. The company is making strong quantitative savings from raw materials costs, Project Carnegie, and pension tailwinds.
The Pittsburgh-based steelmaker has settled its met coal contracts and is expected to cut its coal/coke cost by $25 per ton, although benefits are not expected to begin showing until 2Q14. The company consumes about 9 million tons of coal and could save about $225 million on an annualized basis. It has further announced $100 million of cost savings related to its cost cutting initiative, Project Carnegie, which brings the total savings to $175 million.
The more important factor is that $150 million out of the projected $175 million will likely be realized in 2014. Although the company did not outline the specifics of the cost reductions, most of these savings are in the flat-rolled division. In addition, the company’s unfunded pension and OPEB expenses are also expected to drop by $105 million in 2014. All these actions are expected to save the company $505 million annually, or about 60 percent of 2013 EBITDA. Finally, the company has indicated that its pension and OPEB underfunded liability will decline by almost 50 percent.
United States Steel’s plan to build an Electric Arc Furnace facility to replace its Fairfield blast furnace is also expected to reduce the company’s cost structure and improve flexibility.
United States Steel reported a 4Q13 operating EPS of $0.27, significantly better than the consensus estimates of a loss of -$0.25 per share. The estimated adjusted EBITDA of $245 million also came in above consensus estimates of $182 million. Lower than expected maintenance costs, where the company guided to a sequential increase of $75 million while actual spending increased only by $45 million, largely drove the beat. An adjusted tax benefit of $23 million also added to a difference of about $0.16 per share.
Looking at Electric Arc Furnace to Cut Costs
To cut costs and revamp one of its older, less efficient operations, U.S. Steel has filed permits to construct anEAF steelmaking facility at Fairfield Works to replace the existing blast furnace. Permitting for the project is expected to take 9-12 months from the filling date. This means the company could begin construction in 3Q15 and could complete the project by mid-2017. Once permits have been received, board approval will be sought.
By decreasing the company’s exposure to met coal and coke making infrastructure, an EAF could improve U.S. Steel’s raw materials position. The mill would primarily supply substrate for seamless pipe operations and would have a production capacity of about 1.1 million tons. Although U.S. Steel hasn’t determined the capex for the project, the Steel Dynamics’ (NASDAQ:STLD) study of a greenfield mill in 2011 could be used to drive an estimated cost. Steel Dynamics estimated capex of about $1.0 billion for a 1.7 million ton facility; the Fairfield conversion could be one-half the cost given size difference and existing infrastructure.
What if Steel Prices Decline?
Lower raw materials have historically been negative for the steel industry; in fact low raw materials could be one of the worst things that could happen to the steel industry, as overcapacity translates to increased volumes when margins improve significantly. U.S. Steel, along with other domestic producers including AK Steel (NYSE:AKS), is benefitting from lower input costs. With iron ore and met coal prices already down significantly and now scrap prices starting to decline as well, there are risks that steel prices could decline meaningfully in the near term.
As mentioned in the beginning of the article, the largest U.S. steel maker is expected to benefit from an improving cost structure and has taken plenty of actions lately. The company is also positioned to benefit when a floor in the underlying floor prices emerges. However, the Pittsburgh-based company faces headwinds from weakness in Europe and oversupply of U.S. flat‐rolled products.
The surprising announcement from the U.S. Department of Commerce, which proposed 0 percent duties on the largest exporter of oil country tubular goods, Korea, is also negative for U.S. Steel. It is important to note here that U.S. Steel is the largest OCTG domestic producer. Although we are of the opinion that there can be a significant difference between the preliminary and the final determinations, the preliminary ruling is disappointing for domestic steel producers, including U.S. Steel.