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Balanced View on U.S. Steel

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We are retaining our Neutral recommendation on U.S. Steel Corporation (X), the largest integrated steel producer in the U.S. Adjusted earnings of 41 cents a share for third-quarter 2012 topped the Zacks Consensus Estimate of a break even result on a per share basis. Profit, as reported, doubled year over year to $44 million on the back of a tax benefit.

Revenues, however, dipped 8% year over year to $4,652 million as the company faced challenging economic conditions and pricing pressure in the quarter. It missed the Zacks Consensus Estimate of $4,658 million.

The company expects continued weakness across the European and emerging markets and economic uncertainty in the U.S. coupled with lower steel pricing and shipments to affect its results in the fourth quarter. Nevertheless, it is expected to benefit from lower unit costs for key raw materials.

U.S. Steel is looking for opportunities related to the availability of reasonably priced natural gas as an alternative to coke in the iron reduction process to improve its cost competitiveness while reducing its dependence on coal and coke in the long term.

U.S. Steel is expanding its coke-making capabilities. The company has taken a number of steps in order to ensure long-term access to high quality coke for its blast furnaces. It is in the process of constructing a carbon alloy facility at Gary Works which will utilize state-of-the-art technology to produce a carbon alloy material that will be used as a coke substitute. The Gary Works facility is expected to have a capacity to produce 500,000 tons of coke products at full production level.

The new three-year collective bargaining agreements with United Steelworkers (:USW) represent another positive. The agreements, which are scheduled to expire on September 1, 2015, will offer the employees a 4.5% wage hike and other benefits.

However, a depressed construction market, oversupply in the steel industry and increased domestic imports represents headwinds for the company. Current trends in the steel industry are not quite inspiring. Oversupply in the industry has led to a decline in steel prices as Chinese steel production has outpaced demand.

The U.S. market is seeing increased imports of steel products. Low costs of production in China has enabled the Chinese companies to sell their product at cheaper rates, leading to an industry-wide price decline, which may hurt U.S. Steel’s margins and earnings power.

Macroeconomic concerns, slowing growth in the emerging markets, and a sluggish construction market are still weighing heavily on U.S. Steel’s prospects. Depressed buying patterns by customers are expected to hurt shipment volumes in Europe in the fourth quarter. This leads us to tread with caution.

U.S. Steel, which competes with ArcelorMittal (MT), currently retains a short-term Zacks #3 Rank (Hold).

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