U.S. Steel Faces Reckoning as Carnegie-Era Mills Boost Costs

(Bloomberg) -- For U.S. Steel Corp., there may soon be a reckoning after the rally.

Factories that date back to Andrew Carnegie need more maintenance that will drain cash, and steel prices are set to pull back from record highs as competitors’ new mills begin production. Earnings are expected to shrink across the industry later this year, and U.S. Steel shares, which have led a surge among producers of the metal, may be especially vulnerable, analysts say.

U.S. Steel outperformed domestic peers in the past six months as steel prices more than doubled. But the outsized sway that metal prices have on the company’s stock means it likely faces a rougher road in the second half, even as the economic recovery picks up. The futures forward curve signals a pullback of as much as 32% by the fourth quarter, according to Bloomberg Intelligence.

“The reality is the stock, as it is for all steel stocks, is the beneficiary of the macro environment,” said Curt Woodworth, an analyst at Credit Suisse Group AG, said by phone. “Once we get to the back half of year and more capacity goes into market, the steel price could normalize fairly quickly.”

New plants on the way include a Steel Dynamics Inc. mill opening this summer that will add at least 200,000 tons of steel a quarter and a Nucor Corp. plant set to start up in late 2021.

Meghan Cox, a spokeswoman for U.S. Steel, said that the idea that U.S. steel faces a more difficult second half because of the new capacity is “flawed.”

Reflected in Forecasting

“The market has been aware of the new capacity coming on line and we would assume that is reflected in forecasting,” she said in an email. “The same is true for our planned capital expenditures, which have been public for some time.”

Pittsburgh-based U.S. Steel has said it needs to spend $1.3 billion at its Mon Valley facility, and it will need to shell out more in Europe to maintain an old asset base, according to Credit Suisse.

Steel prices rose more than 70% in 2020 as American producers, surprised by the pace of the recovery in demand from the pandemic, were slow to restart furnaces, leaving a dearth of supply. That fueled the surge in U.S. Steel shares, with steel prices more than double the company’s cash costs of around $550 a ton. To be sure, even the weaker fourth-quarter futures portend good margins.

Shares of U.S. Steel rose 1.2% to $20.86 on Tuesday in New York. The Bloomberg Americas Iron/Steel Index of 12 companies advanced 0.2%.

“Our view is that you’re at peak earnings for the company this year and peak free cash flow, so the market should put a pretty low multiple for a company at peak earnings,” Woodworth said. “We struggle to see how the valuation makes a lot of sense at the current price.”

Capital Efficiency

While an increasing number of companies such as Nucor Corp. use cheaper-to-run electric-arc furnaces to recycle scrap into steel products, U.S. Steel is among those still using more costly legacy blast furnaces.

U.S. Steel, which traces its roots back to 1901 when J. Pierpont Morgan merged a collection of assets with Carnegie, is taking steps to diversify. Last year, it bought the remainder of Big River Steel, an electric arc furnace, to remain competitive as blast furnaces lose market share.

Chief Executive Officer David Burritt told analysts during the company’s earnings call in January that Big River will allow it to be less capital intensive. The producer also has $6.3 billion in pro-forma debt, after issuing bonds to weather the pandemic and purchase Big River, according to Bloomberg Intelligence.

“The question is now, with Big River Steel can U.S. Steel become a much more capital-efficient company?” said Woodworth.

For now, it still mostly operates integrated mills, making its closest domestic competitor Cleveland-Cliffs Inc. U.S. Steel expects $675 million in capital expenditures this year, much of that going toward major upgrades of inefficient plants, whereas Cliffs -- whose 2021 revenue is forecast to be about 35% higher -- sees spending $600 million to $650 million, mostly on basic maintenance.

“There are definitely risks in the second half, and as the steel price comes down it’ll be hard for steel stocks to rally in the face of that,” said Andrew Cosgrove, an analyst at Bloomberg Intelligence.

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