Will United States Steel Corporation Benefit From Rising Steel Prices?
Domestic steel markets have been strong lately, which is a nice respite after a long downturn. All of the major players in the industry should benefit, but United States Steel Corporation (NYSE: X) is facing some self-inflicted headwinds that mean it's not likely to participate in the upturn to the same degree as some peers. Here's what you need to know.
The story of a downturn
At the end of the 2007 to 2009 recession, the steel industry started to hit the skids. It was a painful downturn driven at first by reduced domestic demand. It got worse when foreign imports of low-priced steel products started to flood into the market, at what some claim are unfair prices. To give you an idea of how bad it's been, U.S. Steel has lost money in seven of the last eight years.
During this downturn, U.S. Steel has been focused on adjusting its business to the changing market. That's meant things like cutting costs. A key part of that was a decision to, on the whole, reduce the investment it was making in its business. In 2016 capital spending was less than half of what it was in 2009, with a clear trend of lower and lower spending over the intervening years. That decision helped U.S. Steel get through the downturn, but it has material implications now that the steel industry is recovering.
The first big sign of what's to come showed up in the first quarter. U.S. Steel reported earnings that were much worse than expected and then CEO Mario Longhi made a somewhat startling statement. After acknowledging improving conditions he said, "This remains a cyclical industry and we will not let favorable near-term business conditions distract us from taking the outages we need to revitalize our assets in order to achieve more reliable and consistent operations, improve quality and cost performance, and generate more consistent financial results."
Investors sent U.S. Steel's shares down roughly 30% in the days following that news. The takeaway being that the steel company had underinvested in its business and was now forced to play catch up... limiting how much it would benefit from the upturn. The problem is two fold. First, shutting mills down means they aren't producing steel for sale which obviously hits revenues. But, second, there's a cost to upgrading mills which hits the bottom line. That includes the costs to shut mills down, the cost of the upgrades being made, and then the cost of starting the mills back up.
New CEO, same troubled outlook
Mario Longhi announced his retirement shortly after investors were surprised by that first quarter earnings release. But you can't fix a problem like this by changing the CEO. The only thing the company can do is spend the money it needs to spend even though it's going to be a headwind during an industry upturn. And that's exactly what new CEO David Burritt said when he announced second quarter earnings: "Our investment in our facilities and our people continues to increase."
That's a good thing for the company over the long term, of course. But it means that U.S. Steel is going to be dealing with a self-inflicted headwind right when other companies that didn't pull back on spending, like industry giant Nucor Corporation, are flourishing. If you are looking for a steel investment, you're better off avoiding U.S. Steel -- sure it's going to benefit from an improving steel market, but not as much as better positioned peers.
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Reuben Gregg Brewer owns shares of Nucor. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.