United States Steel Corporation (NYSE: X) is an iconic name in the global steel business. And recently results have started to pick up after a deep industry downturn. Does that make U.S. Steel a buy today? A quick comparison to U.S. steel giant Nucor Corporation (NYSE: NUE) will help answer that question.
United States Steel's business is still largely built on blast furnaces. These are a primary source of steel, but require high utilization rates to turn a profit (U.S. Steel's capacity utilization in the third quarter was around 66%). There's a global oversupply of the metal, which has been a big problem. U.S. Steel has lost money in seven of the last eight years, with the headwind of high costs a major contributing factor. Although it looks like this year will likely end on a positive note, it's important to remember the assets that underpin U.S. Steel's operations.
Image source: Getty Images.
For comparison, Nucor's business is built around electric arc mini-mills. These facilities are easier to turn on and off as demand merits. (Nucor's utilization rate was 86% in the third quarter.) The lower costs of running electric arc mills is one of the reasons Nucor has lost money in only one year over the past eight. It's going to end this year solidly in the black, as well.
There are other factors to consider here, though. For example, U.S. Steel has a largely union workforce that has left it with relatively high expenses. Nucor doesn't have a large union presence and its employees are paid using a unique profit-sharing plan. They are rewarded during the good years and share the pain in bad years. That means that Nucor's compensation expenses fall just when it's most needed. U.S. Steel's unions aren't likely to give it a break without a long and protracted fight.
Looking at the basic business models underpinning U.S. Steel and Nucor suggests that U.S. Steel is at a competitive disadvantage.
The balance of things
And then there's the financial foundation on which U.S. Steel rests. Long-term debt makes up 50% of the company's capital structure. That's not outlandish, but the figure is roughly 30% at Nucor. That provides Nucor with a lot more financial flexibility.
For example, Nucor's financial foundation allowed it to spend the industry downturn investing in its assets, building new facilities, and strategically expanding via acquisition. Meanwhile, U.S. Steel was focused on cutting costs (via its Carnegie Way program) and jettisoning undesirable assets, including the sale of its Canadian business in August of this year. U.S. Steel is doing the right thing for its business, of course, but it was retrenching while Nucor was building for the future.
Some of U.S. Steel's spending plans. Image source: United States Steel Corporation.
That distinction was put on display when U.S. Steel reported a first-quarter loss, leading then-CEO Mario Longhi to explain, "This remains a cyclical industry and we will not let favorable near-term business conditions distract us from taking the outages we need to revitalize our assets in order to achieve more reliable and consistent operations, improve quality and cost performance, and generate more consistent financial results." Investors read that statement as a concession that U.S. Steel was playing catch-up after years of not investing enough in the business. Longhi retired shortly thereafter, but that doesn't change the fact that extra spending is necessary during an industry upturn.
Opportunities and headwinds
Over the past decade, U.S. Steel's stock is down around 70%. And with steel markets strengthening, the near term looks far more promising than the recent past. However, when you compare it to industry leader Nucor, you can see why U.S. Steel's shares have languished.
There's clearly upside potential if new management can get U.S. Steel back on track, but there's a real risk that it misses the current upturn in this cyclical industry because of the retrenching it did in the last downturn. And don't forget about the structural headwinds, including high-cost blast furnaces and a heavily unionized workforce. Most investors would be better off avoiding U.S. Steel and putting Nucor on their watch list in case of a price pullback in the industry leader's shares.
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