U.S. Steel (X) Still a Sell at These Levels
Price Target $15.50

Link to SI News Release

May 25, 2017


US Steel (NYSE:X) has shown a surprising bit of strength over the last couple trading days, and the bullish options activity is off the charts.  Yesterday alone, nearly 40k short duration $21 and $21.50 calls traded hands.  We are a bit puzzled by this sudden shift in sentiment, bearing in mind that today is “death cross” day. 

​It seems as if investors are placing an undue amount of faith in the  Administration's  ability to regulate the
steel market.  The Department of Commerce, under Secretary Wilbur Ross, is conducting an investigation under Section 232 of the Trade Expansion Act of 1962 as amended to determine the effect of steel imports on national security.  According to the DOC, “The Secretary initiated the investigation on steel imports in light of the large volumes of excess global steel production and capacity – much of which results from foreign government subsidies and other unfair practices – which distort the U.S. and global steel markets. Steel is used in a variety of commercial, infrastructure and defense applications.”  According to the Commerce Department, steel imports in March of 2017 were 34% higher than those in March of 2016, “a dramatic increase.”

The investigation began as a result of U.S. Steel’s contention that competing Chinese manufacturers conspired to fix prices in an effort to undercut its American competitors.  Keep in mind that other domestic steel producers are doing just fine.

Yesterday, a hearing was held in Washington, DC during which over 30 speakers (both foreign and domestic) were given a chance to express their views in a public setting.  Naturally, foreign participants indicated that their exports of steel to the United States did not pose a security threat while CEOs of domestic plants contended that they did pose a threat.  Mr. Ross has publicly stated that China increased its steel exports to the United States despite promises to reduce them, and it now commands 26 percent of the U.S. market.  However, China’s Ministry of Commerce said at the hearing that “China’s steel exports to the U.S. have declined by more than 67 percent since September 2015 and the U.S. has enough domestic supply to meet its own needs.”  Keep in mind that Canada, not China, is our largest source of steel and aluminum imports.

Who are we kidding here?  This investigation is not about national security…it’s clearly about the Administration’s desire to revive the sagging U.S. steel industry.  There are several reasons why this is not likely to provide a sustained boost to steel equities.

Reason #1:  First and foremost, this same Department of Commerce at its most recent Section 232 investigation, which was completed in October of 2001 (the month after the 9/11 attacks), concluded that steel and aluminum imports were NOT a national security threat.  If the DOC determined such imports were not a national security threat right after 9/11/2001, why are they a threat now?  At that time, the DOC determined that the entire military’s steel requirements were less than 1% of all domestic steel production capacity, and the Department of Defense used domestic steel in all critical components.  Of the 26 Section 232 investigations completed by the DOC, only 7 resulted in any action being taken.  Is protectionism being disguised here as national security?

Reason #2:  What about Ford (NYSE:F) and GM (NYSE:GM) and other big automakers who are already struggling?  Should they pay more for steel then pass those added costs on to the consumer?  What about companies in the construction sector who account for roughly 40% of steel consumption in the US?  Will the companies that install the Dakota and Keystone pipelines want to pay more for steel?  What about companies such as Boeing (NYSE:BA) that make airplanes and companies such as Whirlpool (NYSE:WHR) that make washing machines?  Will the government be content to pay higher prices for aircraft carriers and stealth bombers?  Is the protection of the steel industry to be at the expense of all others?

Reason #3:  China’s economy is on the decline.  Just this week, Moody’s downgraded China, saying that the country’s mounting debt will wear down its financial strength in the future.  In order to maintain the country’s growth targets, the government will likely be forced to use stimulus measures.  Subsidies to China’s steel industry are a prime example of such stimulus measures.  Despite what it says, China is in no hurry to reduce its production capacity.  It will continue to flood the global market with cheap steel as one means of maintaining stability in the country.  As a side note, Moody’s also downgraded Hong Kong because of its interconnectedness with China. 

Reason #4:  Retaliation.  If we place huge tariffs on imports of Chinese steel, how will China respond?  We would like to sell more beef in China.  We’d like to sell more Apple (NASDAQ:AAPL) iPhones in China.  Are we ready for a tit-for-tat export war with China?

Reason #5:  We need China to deal with North Korea.  North Korea continues to test missiles, and its two most recent launches show the country is nearing its goal of being able to fire a nuclear-armed intercontinental missile capable of reaching the United States.  The country is now ready to begin mass production of a new medium range ballistic missile.  China’s reduction of trade with the rogue nation may be the most effective way to neutralize Kim Jong-un.  Just last month China turned away a fleet of coal–carrying ships, sending them back to North Korea.  Is slapping heavy tariffs on imports of Chinese steel more important than trying to contain the nuclear equipped hermit kingdom?  Mr. Trump himself said that a trade deal with China would be “far better” for China if China solves the North Korean problem.

Reason #6:  Trump’s big infrastructure bill is getting lost in the hubbub of the Administration’s mounting political crises.  Congress, having placed a priority on tax reform and on repealing the ACA, is not helping the infrastructure bill move along.  The infrastructure bill should have been the first piece of major legislation because it most likely would have garnered bipartisan support early on.

The above addresses the steel market in general, but we have reason to be particularly bearish on US Steel.  Last month, the company reported a loss of $0.83 per share, well below analysts’ expectations of earnings of $0.35 per share.  Revenues also fell short of expectations.  Not only did the company miss on the top and bottom lines, it virtually halved its near-term earnings and EPS guidance.  What’s worse, the revised guidance was based on spot prices remaining at current levels.  That’s a fairly rosy assumption.  Factor in slowing demand from auto makers, an expensive plant revitalization process, a new CEO, positive results from other steelmakers.  What we have here is a really good case for being bearish on US Steel, especially given the fact that it is trading at an unusually high forward PE of over 17.

Disclosure:  We are short US Steel.  We do not have a financial relationship with the company.