U.S. Steel Has a Sound Strategy, but Hurdles Remain
Although initiatives have promise, the economic backdrop gives us pause.
While we think U.S. Steel (X) has some promising developments in the pipeline, there is little to look forward to in the near term. Domestic steel prices have been tepid in 2012, and while demand continues to improve, the U.S. economy is not yet strong enough to handle the pressure of weak steel market conditions in Europe and potentially China as well as added domestic supply. The stock price looks attractive, but 2012 will be a challenging year and we see hurdles for U.S. Steel even once demand fully recovers. We believe the company has no economic moat, with a competitive position that is weaker than many steel companies we cover, and we see the potential for further moat deterioration over time.
Operating Rates Strong, but Near-Term Upside Limited
U.S. Steel's annual capacity utilization rate at the North American flat-rolled business exceeded that of the sector as a whole for 2010 and 2011, given the relative strength of the automotive, appliance, and general manufacturing sectors and less exposure to the anemic construction markets. The medium-term outlook for auto and machinery remains positive but slower, and we think there is more upside potential ahead for steel producers with more leverage to growth in infrastructure spending. Further, the flat-rolled markets have seen the greatest volatility in pricing and order rates in the past few years, and that is likely to continue. This is partly due to added domestic capacity by RG Steel, ThyssenKrupp (TKA), and Severstal in the past year as well as added imports. We estimate this segment will represent more than 50% of operating income but is likely to experience the greatest earnings volatility. While import pressure may ease with the slide in steel pricing and shorter domestic lead times, we believe the overall share of imports is consistent with historical levels and, given the relative health of the domestic sector compared with other regions, we see little room for import relief.
Bridget Freas does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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