The steel and metals industries are at an interesting crossroads this year. While the United States is in dire need of infrastructure repairs, requiring vast amounts of domestic steel, there are trade issues with China and Europe and a less robust economy to consider.
Shares of United States Steel Corp. (NYSE: X) were hit hard on Tuesday after Credit Suisse’s Curt Woodworth downgraded the stock to Underperform from an already cautious Neutral rating. The real issue with the equivalent of a “sell” rating here was that the price target was slashed to $13 from $21 in the call, compared with a $19.74 prior closing price.
Woodworth believes that U.S. Steel’s competitive position has weakened ahead of what it called the “Sheet Tsunami.” What really stands out in the call is that the sell-equivalent rating comes after U.S. Steel’s shares were already down by about half from last year’s high.
The new target assumes that U.S. Steel trades at 4.5 times its EV/EBITDA on blended 2019 and 2020 estimates after a deep dive analysis on U.S. Steel Flat-Rolled segment. It concluded that the step-function rise in unit costs the past several years, coupled with a loss of automotive share, suggests that U.S. Steel is in a weaker competitive position than its peers entering the “Sheet Tsunami” period in the United States from 2021 to 2022. The report also sees the market awarding a lower multiple on medium-term earnings.
One issue is that U.S. Steel’s annualized EBITDA guidance of $900 million is highly concerning. The firm derives an approximate $90 per ton increase in U.S. Flat-Rolled unit costs in 2018, with $1.5 billion in total maintenance and outage costs, which is up handily from the $964 million seen in 2016.
Woodworth warned that the hot-rolled coil (HRC) trends starting in 2021 are very bearish for the company. The report, with abbreviations, said:
When the next wave of low cost, HRC focused sheet supply ramps in the US, HRC prices should move to $610/ton on EAF metal spread long term average. We model 2022 HRC at $610/t and forecast U.S. Steel to generate approximately $475 million in EBITDA. Since 2016, U.S. Steel has seen maintenance/outage cost expense rise from approximately $950 million to $1.5 billion with US Flat Rolled capex rising to $820 million in 2018 from $111 million in 2016. This two year free cash flow delta of negative $1.25 billion is central to our downgrade thesis as the pathway is not clear towards higher ROI on this spend. Note U.S. Steel free cash flow in total for 2017 and 2018 after dividends was only $163 million (with HRC @ $695/t).
Along with a loss of the auto share, Woodworth further noted that he struggles to understand why U.S. Steel restarted its Granite City operation, given existing footprint and low margins in HRC.
The market took the downgrade to heart. U.S. Steel shares were last seen trading down almost 8% at $18.17 on Tuesday morning, in a 52-week range of $17.09 to $39.23 and with a Refinitiv consensus price target of $24.71.