United States Steel, formed in 1901, is having a tough year—and it’s getting worse. The stock, down more than 26% in 2019 as of Thursday’s closing price, tumbled another 10.7% in Friday trading after U.S. Steel cut its dividend.
U.S. Steel (ticker: X) cut its earnings forecast and, more important, slashed its quarterly dividend from 5 cents a share to a penny. It was a move that had to happen, and was the result of many decisions by many stakeholders over many years that brought the struggling steel company to this point. Turning U.S. Steel around will be a monumental task.
“While the current realities of the markets we serve are having a significant impact on our short-term results, we are taking swift action to align our operational footprint and financial strategy with our customers’ future,” said U.S. Steel CEO David Burritt in the company’s news release. “Fourth quarter expected results confirm the need to change to make the business more resistant to factors outside of our control.”
Change is needed. That much is certain. Understanding how U.S. Steel got here is important to plotting the best course forward. Here are five reasons U.S. Steel had to cut its divided.
Steelmageddon
It is well known that too much capacity kills returns in commodity industries. And the U.S. steel industry is adding capacity, mostly in the form of lower-cost, electric-arc furnaces that melt scrap steel, rather than producing it from iron ore and coal in blast furnaces, as U.S. Steel historically has done. Companies such as Nucor (NUE) and Steel Dynamics (STLD) are adding primary steelmaking capacity even in a pricing environment that is generating losses for U.S. Steel.
The reason is easy to understand. They still make money. Nucor, for instance, is expected to earn more than $4 a share in 2020. U.S. Steel is expected to lose about $1 a share.
Steelmageddon was the term coined by Bank of America analyst Timna Tanners to reflect the effect new capacity will have on margins in the future.
Industry Structure
The global steel industry could use some consolidation. The largest steelmaker in the world— ArcelorMittal (MT)—accounts for less than 6% of global raw-steel production. That’s not a lot.
Just three companies, by contrast, dominate the market for low-cost iron ore: BHP Group (BHP), Vale (VALE) and Rio Tinto (RIO.London).
Consolidation by end market can help too. That’s what Barron’s suggested when we posited that Cleveland-Cliffs (CLF) could sell AK Steel’s (AKS) finishing assets, a move that would amount to a consolidation of the downstream steel business in the U.S. Cliffs is attempting to buy AK Steel.
Imports
The largest source of steel in the U.S. is imports. There is some nuance to that fact—differences by end market and product type matter and imports fluctuate from month to month—but it is still a surprising idea.
Imports are the so-called marginal ton of steel in the U.S. That means they are the last ton to satisfy market demand. Economically speaking, it means imports set the price for steel in the domestic U.S. industry. Practically speaking, that means domestic steel producers live a volatile existence with prices fluctuating widely.
The U.S. imported about 33 million tons of steel products in 2018. Nucor shipped about 25 million tons.
Tariffs
Tariffs are not a panacea. They get put on and they get taken off. President Donald Trump tweeted about the U.S. Steel mill called Granite City restarting after tariffs were put in place. Now, U.S. Steel is losing money again.
Tariffs as a policy make some sense in steel. Even staunch free-market traders might agree. China produces about half of the world’s steel—the world makes about 1.8 billion tons annually—and most of Chinese capacity was funded by government cash. It isn’t a level playing field. What’s more, the U.S. market is, in some respects, a dumping ground for Chinese steel. China ships metal it can’t use internally overseas.
A more comprehensive and consistent tariff regime would help U.S. Steel and the entire domestic industry.
Management
Corporate executives always deserve some of the blame when things go bad. The buck has to stop somewhere. In the case of U.S. Steel, the company is a high-cost producer in a commodity- based industry. That is a tenuous position to be in.
What should management have done? Relentlessly pursue cost reductions over decades.
U.S. Steel, for instance, is adopting electric-arc furnace technology, the kind Nucor runs. It requires less capital and is more flexible. An EAF doesn’t always have to be on, while a blast furnace does. Pursuing lower-cost technology is a good idea.
But U.S. Steel is late to the game. Dofasco, a Canadian steel producer that started out with blast furnaces, for instance, moved into EAF at the end of the 20th century. Dofasco was bought by ArcelorMittal in 2006.
Consolidation, regulation and cost cutting all have a role to play in any U.S. Steel rebound. Based on recent stock-price action, it appears investors will be watching developments from the sidelines. U.S. Steel stock dropped 10.7% to $11.92 Friday. The stock’s losses this year stack up poorly, to say the least, against the gains in the Dow Jones Industrial Average and S&P 500.
Write to Al Root at allen.root@dowjones.com
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December 20, 2019 at 11:13PM
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U.S. Steel Cut Its Stock Dividend. Here Are 5 Reasons Why. - Barron's
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