United States Steel Corporation

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

United States Steel Corporation is a leading integrated steel producer, with operations spanning across flat-rolled and tubular segments primarily in North America and Europe.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

U.S. Steel is a significant player in the steel industry, a sector often characterized by cyclicality and intense competition. The company’s business model encompasses:

  • Flat-Rolled Steel Products: This segment includes the production and sale of various steel sheets, strips, and plates used in the automotive, appliance, construction, and container industries. It is a crucial part of U.S. Steel’s revenue base and directly correlates with the demand for these sectors.
  • Mini-Mill Segment: Utilizes an electric arc furnace for steel production, offering cost advantages over older integrated mills. These mills produce flat-rolled products and are often located near customers for fast turnaround times.
  • USSE: The U.S. Steel Europe segment is primarily involved in producing steel sheets and plates, with operations in Central and Eastern Europe. This segment’s performance is heavily influenced by European industrial demand and trade regulations.
  • Tubular Products: This segment focuses on the production and sale of seamless and welded tubular products for the energy sector, including oil and gas drilling and infrastructure. It is therefore highly susceptible to fluctuations in the energy markets.

U.S. Steel’s operations are characterized by a vertical integration from raw material sourcing to finishing steel products, allowing them to control quality and supply chain elements.

The steel industry faces several structural and cyclical challenges. The market is highly competitive, with both domestic and international players vying for market share. Pricing and production decisions are heavily influenced by global supply and demand, with an intense rivalry for customers. Some significant trends include:

  • Cyclicality: The demand and pricing for steel are closely linked to the economic cycle. This makes steel companies’ profits volatile, with periods of high demand and high prices often followed by periods of oversupply and price declines.
  • Globalization: Steel is a global industry, with production capacity and demand shifting across various geographies. This has led to heightened competition and price pressures, requiring steel producers to control costs and find cost efficiencies.
  • Increasing Imports: The global market continues to face increasing steel imports, particularly from Asian countries with lower production costs. This creates pricing pressure and erodes the margins of producers in the domestic market.
  • Shift to Electric Arc Furnaces: Newer mini-mills, using electric arc furnaces (EAFs), are more efficient and have a smaller environmental footprint than traditional blast furnaces. Companies who have not adopted to the technology, are at cost disadvantage.

Despite the competitive environment, some trends can benefit U.S. Steel as well. For instance, government infrastructure projects may spur demand for steel products in the short- to medium-term. Moreover, the company’s position in the market means it is well-positioned to capitalize on opportunities where demand outpaces supply.

Competitive Advantage or Moat Analysis:

U.S. Steel has some advantage through integrated operations, but lacks a truly sustainable moat. Here’s a rating with the justification:

  • Rating: 2/5
  • Scale Economies: While U.S. Steel has some cost advantages arising from its scale (especially in specific markets), they’re not unique and easy to copy. A newer, more efficient plant could quickly render U.S. Steel’s larger, older plants as less competitive. They could have economies of scale, but they aren’t unmatchable and unachievable for competitors. * Unique Resources: U.S. Steel mines coal, iron ore, and other raw materials for their steel production; these are not proprietary, and prices are influenced by global supply and demand. * Switching Costs: For customers, switching steel suppliers is relatively easy and does not involve considerable cost, hence they can buy from wherever they get the best product and price. There is also large fragmentation and competition in the steel market. * Intangibles: U.S. Steel’s brand has a long history, but in a cyclical, price-driven, commodity market, the brand carries less significance than in markets where quality is a core factor. * Network Effect: Does not apply to steel production.

Risks

U.S. Steel’s moat is vulnerable to a number of factors:

  1. Economic Cyclicality: As steel prices and demand fluctuate with broader economic trends, the value and profitability of U.S. Steel are highly susceptible to market pressures. A prolonged economic downturn would hurt the company.
  2. Pricing Power: The steel market is commodity-like where pricing can fall due to global oversupply and increasing imports, limiting pricing power. Therefore, cost competitiveness is paramount, as prices are set by market forces.
  3. Raw Materials Prices: Changes in raw material costs, such as iron ore and coking coal, significantly influence input costs and can erode margins.
  4. Technological Disruption: EAF (mini-mill) technology, and other newer innovations could make U.S. Steel’s facilities less competitive and therefore lower returns on capital.
  5. Environmental Regulations: Stricter regulations on emissions and carbon footprint will significantly drive up costs in the long-term.
  6. Geopolitical Risks: International conflicts or changes in trade policies could cause market volatility and pricing fluctuations and affect U.S. Steel negatively.

Business Resilience

U.S. Steel’s business demonstrates a moderate level of resilience:

  • Financial Stability: U.S. Steel has improved its financial position by deleveraging its balance sheet and improving profitability, but still faces fluctuations related to market cycles.
  • Operational Flexibility: The company has taken steps to increase operational flexibility by utilizing different production methods and production flexibility.
  • Strategic Adjustments: U.S. Steel is focusing on efficiency improvements and exploring new technologies to navigate a changing market; however, the success of the strategy relies on continuous implementation, and a quick turnaround is not guaranteed.
  • Diversified Operations: The company’s production base is somewhat diversified, which should provide some resilience during certain industry trends.

Financials:

Based on the Q1 2024 earnings results:

  • Revenues: Net sales for the first three months of 2024 totaled $4.1 billion, a decrease compared to $5.2 billion in the prior year period and $4.5 billion in Q4 2023. Revenues dropped due to lower average steel selling prices and lower shipment volumes.
  • Profitability: Net income came in at $119 million, a huge drop compared to the prior year’s $975 million. Similarly, earnings per share was 0.61 vs. 3.86. This significant decline was due to margin pressures in the steel segment and operating performance. The company also took on restructuring and other charges.
  • EBITDA: Ebitda declined drastically to $403 million from $1,479 million in the same quarter last year, while the EBITDA margin fell to 9.4% from 28.3%.
  • Cash Conversion Cycle: Days Inventory Outstanding (DIO) has increased to 40 days from 34, and Days Payable Outstanding (DPO) has also increased to 70 from 51 in prior year. Cash conversion cycle has decreased by 10 days from 54 days in Q1 2023 to 44 days in Q1 2024.
  • Net Debt: As of March 31, 2024, net debt was $2.3 billion, a huge drop from $6 billion at the start of 2023.

Balance Sheet:

  • Assets: Total assets at the end of Q1 2024 stood at $20.4 billion, indicating a reasonable asset base for its operations. Total assets are approximately the same as compared to December 31, 2023 ($20.6 billion)
  • Liabilities: Total liabilities are at $10.8 billion, having an equity of $9.6 billion. Both debt and equity show a healthy structure.
  • Liquidity: U.S. Steel has a very good amount of cash and equivalents on hand, at $1.75 billion, which helps its position in case of distress. Total available liquidity is at $2.68 billion.

U.S. Steel’s current balance sheet has improved due to the company reducing a substantial amount of debt. However, the recent financial performance has faltered due to the macro environment (lower steel prices), highlighting how susceptible they are to industry wide dynamics.

Understandability:

  • Rating: 4/5
  • The business is mostly in one area, steel production, and their financial statements are easy to understand. The company’s operations, though industrial, are relatively straight forward and can be easily understood. It is a cyclical business so that will have a big effect on financial statements and share price volatility, which can make it hard to understand the long-term earnings.
  • While understanding the core business is relatively simple, forecasting earnings and valuation can be complicated by industry cycles and global trade dynamics.

Balance Sheet Health

  • Rating: 4/5
  • As explained earlier, U.S. Steel has improved its balance sheet by significantly reducing its net debt position. However, this does not mean that the company has eliminated all debt; it also has a significant amount of lease liabilities. In the previous year, they had high long-term debt obligations, and the decrease has greatly strengthened their balance sheet.
  • The current amount of cash and equivalents of $1.75 billion helps maintain liquidity for upcoming challenges.

Recent Concerns and Management Commentary

  • Strategic Review: The company is currently undergoing a strategic review process, which was initiated after the company received a buyout bid from Cleveland-Cliffs, and other steel companies. The company was initially reluctant but has now stated that all strategic options are on the table, including a sale of the company.
  • Deteriorating Earnings: The company’s recent quarterly results have shown a dramatic drop in revenues, earnings, and margins and management acknowledges the problems. They cite lower steel prices and lower volumes as reasons, however, many other companies have not faced these severe issues.
  • Labor Relations: U.S. Steel is in active negotiations with the United Steelworkers, which represent its unionized employees. The management mentioned that they are making progress in this area, and that they had reached an agreement with the USW to provide a pathway to share earnings with employees. However, there are possibilities of future conflicts arising in contract discussions.
  • Trade Dynamics: U.S. Steel is still exposed to trade challenges and market imbalances, and therefore, imports are still a matter of concern for the company.

Recent earnings call comments indicate that management is focused on improving its operations, making strategic choices, and maintaining long-term stakeholder value. They are working to decrease the high cost structure as compared to competitors, while also working to diversify the revenue stream by acquisitions and joint ventures.

U.S. Steel has a decent level of resilience, with improving financials and management looking to make necessary changes for the future. However, it is still highly influenced by industry-wide volatility and price volatility. Also, the future of the company is uncertain given the possibility of an acquisition. Overall, the company looks like an interesting investment, provided that the valuation of the company is right.