U.S. Steel Company

The X marks the spot

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Throughout July, I discussed in the private community Discord the investment idea in U.S. Steel, focusing on its transformative plan and strong cash generation capability at heavily discounted prices, with the intention for it to be the corresponding investment analysis for the month of August. Unfortunately, the company has received several tender offer bids over the past two weeks, which have prevented us from accumulating a significant position at the ridiculously low prices from 1 month ago, as they have caused a 40% increase in value.

Nevertheless, the idea remains very interesting: it is important to thoroughly understand the operations, finances, and potential of the company, as well as the details of the tender offer bids, in order to evaluate our options as investors.

Introduction and business model

United States Steel Corporation (X) is a steel production company founded in 1901 in the United States by Andrew Carnegie, Elbert Gary, J.P. Morgan, and Charles Schwab. The company's history is that of a fallen industrial giant, now rising from 50 years of depression after having been, nearly a century ago, the world's largest company and the first to surpass a $1 billion valuation. Its facilities are located in the United States and Europe (with a plant in Slovakia), encompassing all segments of the value chain: pig iron production (iron ore transformed for use in steel), foundries, and finishing plants.

Recently, they have increased their capacity to produce iron ore, which now exceeds their production needs in the USA, leading to them selling the excess to other companies (they have long-term contracts for this supply). However, for their European operations, they acquire this input, creating supply chain risk and price volatility. Similarly, they don't produce coke, a key input for their operational process; instead, they purchase it, meaning they lack control over another crucial aspect of their operations. Nevertheless, this is a common practice, and they are one of the most vertically integrated steel companies.

They produce steel for various uses and industries. Specifically, the company operates in four business segments:

• Flat Rolled: This encompasses the production of plates, iron ore, coke, slabs, etc., in the USA. Their main customers include the automotive industry, appliances, pipes, containers, and industrial equipment. In 2022, the production capacity for this segment was 13.2 million tons, although they had shutdowns totaling 1.4 million tons due to market weakness.

• Mini Mill: This includes the assets of Big River Steel and a second mini mill currently under construction in Arkansas. They produce rolled steel sheets and electrical steel, which possess special electromagnetic properties making them ideal for applications in motors, generators, and transformers.

• European Operations: This includes the operations of the Košice plant in Slovakia. It serves the company's customers in Central and Eastern Europe, primarily in the transportation, construction, appliances, electrical, and petrochemical sectors. It has a maximum total capacity of 5 million tons, and in 2022, it utilized 3.8 million tons due to energy issues on the continent.

• Tubular: They produce tubes, pipes, steel casings, and nuts, mainly for the oil & gas industry. Currently, this segment has the lowest performance due to high inventories, overcapacity, and weak demand.

The majority of their sales (76%, 61%, 48%, and 78% for their Flat Rolled, Mini Mill, USSE, and Tubular segments respectively) are made through medium to long-term contracts, with the rest on a spot basis. This provides some visibility and predictability to their revenue and earnings. Steel is a crucial element for economic advancement, with applications in nearly all sectors of activity: construction, infrastructure, automotive (particularly significant growth in electric vehicles), renewable energy, oil & gas, containers, and more. In the following table, US Steel breaks down its customer segments for the past three years, with clear growth in the automotive industry.

There are many tailwinds for both the sector and the company. The steel industry is highly cyclical by nature: it's a doubly affected sector, as it's sensitive to both the capital cycle (if returns are very high, new supply enters the market, although this is increasingly challenging due to significant initial investment and environmental regulations) and the economic cycle (many end-consumer industries of steel, such as automotive or construction, move with economic booms and downturns). Nevertheless, the demand for steel is expected to follow a growing trend based on the progress of developing markets like India, Africa, and other APAC countries.

The consensus points to a 1% CAGR growth for the next decade, led by countries like India with projected rates of 4.4% growth until 2050. However, certain higher quality and technology steels, like non-grain oriented (NGO) steels used in electric vehicles, which the company produces, are expected to grow even more, at a 7% CAGR.

Another major tailwind for both the sector and the company is deglobalization, which is the phenomenon of ensuring supply security within one's own country. For decades, the general trend was to outsource production and invest outside the country, leading to the expansion of supply chains. The pandemic highlighted the fragility of this system when quarantines and labor shortages jeopardized entire value chains, leading to rampant inflation. The Inflation Reduction Art and the Bipartisan Infrastructure Law also represent significant commitments and incentives for investment in the USA, with over $300 billion in committed spending, of which the company is a clear beneficiary.

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Investment thesis

With a clear understanding of what the company is engaged in and the environment and sector in which it operates, it's time to focus on the specific numbers and outlook of U.S. Steel. We will divide the analysis into the following four sections:

• Operations

• Balance Sheet

• Expansion and Shareholder Return

• Tender Offers

Let's review each of these points in detail.