US Steel working on makeover to remain relevant

The $700mn purchase of nearly half of Big River Steel comes as US Steel struggles with a more competitive steel market in which investors have soured on the company's stock and its basic oxygen furnace (BOF)-based assets have failed to compete in the low price environment.

US hot-rolled coil (HRC) prices have been volatile in the last two years, with prices increasing in 2018 due to the US imposition of 25pc steel tariffs. As China and the global economy have since slowed and steel prices globally have fallen, US HRC prices have now dropped to levels lower than before the tariffs were imposed.

US Steel's purchase of Big River marks a major shift in the integrated steelmaker's strategy to diversify itself into the more cost-effective EAF space, with Big River a cornerstone of that change. The EAF mill is currently doubling its production to 3.3mn st/yr. At the same time US Steel is constructing a 1.6mn st/yr EAF at its Fairfield Works near Birmingham, Alabama.

US Steel has the option to buy the rest of Big River in the next four years, which chief executive David Burritt said he intends to carry out.

The two EAF's would raise US Steel's demand for ferrous scrap and metallics in order to feed its 5mn st/yr capacity.

Some of those metallics could be provided by US Steel's own pig iron operations, which the company draws on for its integrated steelmaking mills.

"What the company is doing … is upgrading their capabilities to be sustainable and relevant for what the future is going to look like," KeyBanc Capital Markets analyst Phil Gibbs said.

The move comes after US Steel idled two blast furnaces in July, cutting production by up to 225,000st/month.

Nimbler EAFs, aided by the US' reservoir of domestic scrap, have taken considerable market share from their iron ore-fueled BOF counterparts in recent years. EAFs make up the majority of US steelmaking capacity at 68pc, compared to 32pc for the BOFs used in integrated mills, according to the American Iron and Steel Institute.

While new EAFs are planned or under construction in the US, the most recent BOF was constructed at US Steel's Gary Works in 1973, according to the Association for Iron & Steel (AIST). EAFs and BOFs last held roughly equivalent capacity in 2002.

Part of a wider strategy

The move to buy Big River is part of a wider strategy by Burritt to realign the company around three core assets in order to combine the capabilities of integrated mills with the flexibility of EAF steelmaking.

The first of those assets is the 1.65mn st/yr Big River mill and its management team, which Burritt hopes will provide expertise in optimizing the asset. Big River's expansion will, when completed next year, lift the mill's capacity past some of US Steel's other operations.

The second core asset is the integrated steelmaking complex of Mon Valley Works, which can produce up to 2.9mn st/yr of raw steel. US Steel said it will spend $1.2bn on upgrades through 2022 on new facilities that the company says will cut production costs by $35/st.

The final piece to Burritt's plan is investing $750mn in the integrated steelmaking complex at Gary Works, Indiana, the largest in US Steel's arsenal with an annual production capacity of 7.5mn st, including $500mn devoted to the hot strip mill at the site.

Questions about US Steel's financial state

Some have questioned the timing of the buy, which comes as US Steel spends billions of dollars on upgrades.

Bank of America Merrill Lynch analyst Timna Tanners wondered why US Steel chose this moment, when the global economy is slowing down and steel prices are under pressure, to add more debt to its books.

Tanners says while US Steel may be planning for $600/st hot-rolled coil (HRC) prices to be the new normal, she sees pricing more in the $500-$550/st range in the near future.

At the same time, US Steel's chief financial officer announced plans to leave just as the company is seeking to raise the funds for the Big River purchase.

The Argus weekly domestic US HRC index fell by $4/st to $538/st ex-works Midwest this week as some sources said spot prices could be dipping as far as $500/st or lower. US HRC steel prices have dropped 27pc since the beginning of the year.

After 2018 profits of $1.115bn, US Steel's best performance since 2008, the company's earnings through the first half of 2019 are $122mn, with US Steel expecting a loss of up to $94mn in the third quarter. The company's stock has fallen by 58pc since its 2019 peak in February.

Gibbs says a big problem is that US Steel has yet to secure funding for its purchase and investors are concerned over whether or not US Steel can survive the next two and a half years.

"I could go out an buy a Maserati but at what cost and people would be questioning why I did it," he said.

What next for US Steel's other assets?

Assuming Big River completes its expansion and is fully purchased by US Steel, the company's three core assets would have an annual production capacity of 13.7mn st. The total capacity of its active steel mills would rise to 21.9mn st.

That would leave a large gap between US Steel's production capability and its actual production. Production in 2018 totaled just 11.9mn st - higher than the 10.7mn st of raw steel it produced in 2016, but far below the nearly 17mn st produced in 2014.

With the market believing it's oversupplied, some wonder what will happen next with US Steel's other assets.

The company may have some answers.

US Steel said the Big River purchase could allow it to achieve $1bn in capital and operational cash improvements by 2022 by reassessing its $2bn asset revitalization program it announced in August 2018. A new operating model [announced on 8 October] (https://www.argusmedia.com/metals-platform/newsandanalysis/article/1992423-US-Steel-makes-changes-to-further-integrate-Big-River) is expected to save US Steel $200mn in annual costs by 2022.

Questions remain about the role US Steel's Granite City Works, which was restarted in 2018, will play in the company's mix. The mill has an annual production capacity of 2.8mn st.

US Steel's foray is different from the routes taken by other integrated US steelmakers. ArcelorMittal's integrated US steel mills are continuing to operate, with the company's chief executive saying in August that he had no plans to reduce capacity in the US.

For AK Steel, which has a mix of integrated and EAF mills, it has turned its focus on steel for the automotive and electrical industries, with most of its production going toward the automotive industry.