We reiterate our Neutral recommendation on United States Steel Corporation (X), the fifth largest steel producer worldwide.
U.S. Steel’s operating results have started reflecting the benefits of the gradual economic recovery in North America and Europe. The company’s raw steel capability utilization rate in the first half of 2010 was 78% for the North American operations and 88% for the European operations, substantially higher than the operating rates of 35% and 56%, respectively, in the first half of 2009. In the second quarter of 2010, the company operated its raw steel facilities at above 90% of the total capacity.
U.S. Steel’s Flat-rolled raw steel capability utilization rate of 82% in the second quarter of 2010 reached the highest quarterly operating rate since the third quarter of 2008. US Steel has resumed operations at all of its 15 previously-idled blast furnaces. The company recently restarted operations at its Lake Erie facility which increased steel shipments by 14%. We believe that improving capacity utilization should ensure the company’s profitability in the latter half 2010.
About 54% of U.S. volumes and 29% of European volumes are under mid- to- long term sales contracts, which have been renegotiated at higher prices. U.S. Steel has significant leverage to improving prices and volumes. The company benefits from its focus on value added products such as cold-rolled and coated carbon steel, which are used in auto, appliance, electrical and container, as well as the oil and gas industries. Its peers, such as Nucor Corporation (NUE), focus on core steel products.
However, rising supplies from China, low demand from the automotive and residential sectors and rising labor costs are affecting its operations. The company’s Flat-rolled segment is still weak and continues to face lower shipments and higher raw material costs. We believe that the benefits of expected increases in average realized prices and higher shipments in the Tubular segment should be offset by increased costs for steel substrate. Though the company broke out of the loss territory and delivered net earnings in the second quarter of 2010, it lagged the Zacks Consensus Estimate.
On a price-to-book basis, U.S. Steel currently trades at 1.5x, a 6% and 59% discount to the industry average and S&P, respectively. Nevertheless, we expect global steel demand to improve in the long term. Our long-term Neutral recommendation on the stock indicates that U.S. Steel would perform roughly in line with the broader market. Our six-month target price of $48.00 is based on a target P/B of 1.6x.
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