TLDR: U.S. Steel is significantly overvalued because they are not able to reduce capital expenditures and are sensitive to economic conditions. IV is $277 million, company trading at $6.53 billion.
History
U.S. Steel (USS) was founded in 1901 by Andrew Carnegie. It was at one point the largest company in the United States, credited with being a key driving force behind much of the development in the early 20th country in North America. Their product has notably been used to construct the Willis Tower, the United Nations building, NASA’s vehicle assembly station, the New Orleans Superdome, among many other iconic structures.
They weathered the great depression by shifting towards consumer oriented production intended for use in household goods, as well as modernizing despite the economic conditions. During World War 2, USS’s steel was used in the construction of ships, tanks, planes, and weapons. The company we see today was formed by a public offering and split of two companies in the early 2000’s.
Strategic acquisitions in 2003 and 2007, despite a tough steel industry, allowed USS to grow its capabilities. In 2018, they began an initiative called “Best of Both”, which is purposed to better serve customers with integrated and mini mill steelmaking technologies. In 2021 they announced the renaming of the initiative to “Best of All”, and added improvements to their environmental policy.
Today, they have operations in the U.S and Europe. They are the 20th largest public steel company in the world with a market cap of $7.1 billion. As with almost all commodity businesses, we must consider operational costs and recurring investments. Steel requires steep capital expenditures, and comparing changes in these values to company decisions can be one factor determining if the company employs capital rationally.
They have an entire website dedicated to one of their facilities polluting Pittsburgh, https://pghcleanair.com/. In Pittsburgh alone they have been fined 6.65 million in the past 9 years. Social media posts about the company are overwhelmingly unfavorable, mostly citing unfavorable opinions about management and an abysmal environmental record.
Description
The current company has a production capability of 22.4 million tons. Their typical customer is in the automotive, construction, consumer packaging/appliance, electrical, industrial, or energy field. The four segments of the company are:
– Flat rolled
– Mini mill
– Tubular
– European operations
Flat rolled is averaging 67% of capacity, producing 8.8 million tonnes last year. Mini mill is averaging 80% capacity at 2.7 million tonnes. European operations produce 3.8 million tonnes at 76% capacity. Tubular is averaging 70% capacity at 634 tonnes. This amounts to a total utilization of 71%.
The “Best for All” strategy the company is urgently using as their mantra boils down to cutting costs and gaining competitive advantages.
David Burritt has been CEO since 2017. He is optimistic for a company generally considered to be in decline. Only half of the company thinks he is a good CEO. To set the stage, steel prices increased at the beginning of 2021, and remained at a level above 50% of the previous for almost the entire year. He described declining business in 2022 compared to the record year of 2021. Prior to the war, they bought inputs from Russia and have since been purchasing from other sources.
Finance
In the 2010’s, USS struggled to stay profitable. The past two years have been exceptional. Assets have nearly doubled and the company has built up a sizable cash position, despite the shortfalls of management, the company is in a favorable position. Good times come to an end, revenue is down 20% from last quarter, and net income is down over 80%, due to the company inability to keep COGS at a competitive relationship with revenue. The current financial results are indicative of the pre 2021 bump. The recurring, high, and predictable capital expenditures of the company should be considered part of operating cash flows. They have only had three years of positive return on equity prior to 2020 and following 2010.
The randomness of the capital expenditures and recurring large costs creates a strange situation. The company performance cannot be determined from looking at one-year cycles, instead the horizon must be extended to explain why some years the company has exceptional earnings. Instead, we must look at the balance sheet structure, and long-term averages to understand the direction of the company.
Significant implications can be drawn from U.S. Steels performance in 2007-2008. 2007 was a record year, and the company experienced a 50%+ drop in revenue. Net income went from over $2 billion to $1.4 billion in the red. A run up on assets before 2008 was almost symmetrical to the slow bleeding experienced after, 2004 and 2014 have similar looking balance sheets. The company issues share and was forced to reduce investment. The company was in a fight for its survival, and the actions to prevent catastrophe had long term consequences. The company is extremely exposed to economic volatility, and revenue fluctuates but does not show promising long-term growth. This is a mature company.
| Metric | Most Recent Value | 30-year average |
|---|---|---|
| ROE | 25.5% | 3.7% |
| ROA | 14.2% | 1.8% |
| Profit Margin | 12% | 0.8% |
| D/E | 0.39 | 1.07 |
| Net income per employee | $111,000 | $9,000 |
The company is in an exceptional position. There is a possibility for them to return tremendous value to shareholders, but there is also the possibility that the company attempts to grow their operations where it is clearly not in their best interests to do so. If there was a single action that this company should do, it is to reduce capital expenditures, which is the highest utility, both to the shareholders and the company’s future outlook.
What is certain is that the company will not see years like 2021 and 2022 in the foreseeable future. In constructing the DCF, we must account for the current position by making a positive adjustment. The company cash flow is trending downwards without the past two years, but slightly upwards with one. The premium for high performance in the past two years will be to assume the ability to increase free cash flow slightly in the next ten years, at a rate of half a percent yoy. Assuming we use the $28 million recommended by taking the average if the past (highly cyclical) decade, and using our half percent growth rate, and a decaying risk free rate from 4% to 0% over 10 years (a relative mean reversion to target inflation), we reach an intrinsic value of $277 million, which is less than 5% of the market value.
U.S. Steel is significantly overvalued, and they struggle to improve cash flows because they are unable to reduce capital expenditures. The fallacy of the current company standings encourages conservative investors who do not do in dept research. Unless there is a technological breakthrough in steel fabrication, this company will not improve their intrinsic value.
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