Heard Off the Street: U.S. Steel woes surprise analysts

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Cost-cutting has been a major contributor to the improvement in corporate earnings since the 2008 financial crisis. Growth in revenue has been limited because the U.S. economy has grown at a ho-hum 2 percent pace since then, leaving companies limited options for increasing their bottom lines.

So it comes as no surprise that U.S. Steel, which last reported an annual profit in 2008, is taking another run at reducing costs. Chairman and CEO John P. Surma last week announced a thorough review of purchasing, logistics, repair and maintenance and other functions. The initiative will be overseen by chief operating officer Mario Longhi, who joined the Pittsburgh steel maker last summer after six years at Brazilian steel producer Gerdau and 23 years at Alcoa.

Mr. Surma did not say how much in savings will be targeted, only that it will be significant. During a conference call with analysts Tuesday, he promised to use a big stick.

"Our spending in these areas is in billions of dollars annually, and a small percentage reduction would be very meaningful to our results," he said.

The undertaking was disclosed as U.S. Steel reported a first quarter loss of $73 million, or 51 cents per share, a performance worse than Wall Street analysts were expecting.

Some of them find it hard to believe that the company is not performing better. They cite several reasons why it should be, including the company's cost advantage in iron ore -- it mines its own ore while many competitors have to purchase theirs -- and the rebound in the automotive market, one of U.S. Steel's biggest customers.

"We thus find it difficult to explain why their results haven't been better than reported," analyst Charles Bradford said in a note to clients.

In an interview, Mr. Bradford said the cost cutting is "desperately needed" and questioned why it had not been done sooner.

"This is a commodity business. In a commodity business, you have little or no control over pricing. The only thing you can control is your costs," he said.

Morningstar analyst Bridget Freas also is surprised U.S. Steel has not been more profitable, given its iron ore edge.

"It's because there are so many other things in their cost structure that offset that," she said.

Any cost-cutting efforts will be hampered by the company's labor agreements with the United Steelworkers union, commercial contracts and other factors, said John Tumazos, a Holmdel, N.J., analyst. He said renegotiating medical benefits for union workers and retirees could result in substantial savings. But a good portion of those costs were fixed in September, when USW members ratified a three-year labor agreement covering about 17,000 U.S. workers.

Mr. Surma's "mission appears to be to save more than nine figures, or $4 to $5 a ton. Given the condition of the steel market, they need something like $20 or more," Mr. Tumazos said.

Having Mr. Longhi, a newcomer to the company, manage the review should be a good thing, he added.

"He is not accustomed to the status quo and has a fresh look," Mr. Tumazos said.

Ms. Freas said repair and maintenance costs appear to be one area where U.S. Steel could save money. The lockout of USW workers at the company's Lake Erie Works in Canada, initiated by the company last Sunday, presents another opportunity.

"They kind of need to play hardball on the labor agreement because this company is just bleeding money," Ms. Freas said.

Vendors, headquarters and salaried employment costs are three potential areas for savings, Mr. Tumazos said.

"The greatest savings are if they eliminate a site and all the infrastructure associated with it," he said.

Cutting the company's 5-cent-per-share quarterly dividend would save about $29 million. But Mr. Bradford said that might undermine the company's message that it is managing its cash flow well.

Whatever cost reductions U.S. Steel will realize could be offset by the weak industry conditions analysts are forecasting for the months ahead, including falling iron ore prices. That will lead steel buyers to seek lower prices based on the industry's lower raw materials costs. It will also reduce U.S. Steel's iron ore edge, analysts said.

In its earnings release, U.S. Steel said first quarter prices were below 2012 averages, including tubular goods, a market where the company faces stiff competition from imports. First quarter tube prices were 10 percent below levels in the year-ago quarter and 8 percent lower than average prices for all of 2012.

The lackluster outlook prompted some analysts to lower their earnings outlooks for the company, including Luke Folta of Jefferies. He told clients last week that industry profit margins won't improve until demand does, something he does not anticipate happening until the second half of the year at the earliest.

On Tuesday's call, Goldman Sachs analyst Sal Tharani said the cost cutting will have to be dramatic given that the company is struggling to make a profit at current prices. He noted that iron ore, currently selling for about $130 a ton, is forecast to fall below $100 a ton in 12 to 18 months.

"We need to make sure we drive our break-even point down further than it is today, and that's what our objective is," Mr. Surma responded.

bizopinion

Len Boselovic: lboselovic@post-gazette.com or 412-263-1941.


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