U.S. Steel's (NYSE:X ) performance has taken a massive beating in the last six months as the stock has lost almost 30% of its value. This is not surprising as the steel industry in the U.S. has been under pressure due to a variety of reasons, such as a surge in imports, pricing pressure and low energy prices. U.S. Steel was forced to undertake a slew of measures earlier this year, including idling of plants and laying off workers in order to sustain itself in the current market environment. But, the key question is, can U.S. steel execute a turnaround going forward? We'll check this through a SWOT analysis.

Despite the weakness in steel pricing, U.S. Steel has managed to improve its key financial metrics as shown in the chart given below:

X Cash from Operations (TTM) data by YCharts

This might look surprising at first, especially considering the current steel environment. But, U.S. Steel has made smart moves in order to improve its operational performance, driven by its Carnegie Way initiative.

For example, U.S. Steel's decision of constructing a $230 million electric arc furnace (EAF) at its Fairfield Works will improve its margin performance further. The company has traditionally used a blast furnace for decades, but the additional costs associated with this infrastructure makes it extremely difficult to be used as a competitive means of production. With the new EAF technology, U.S. Steel will be able to better compete with its peers in the global market as it will become more nimble and will be able to produce steel from cheaper sources.

This transition may have some near-term impact on its balance sheet as EAF requires substantial upfront investment. But, over the long run, the EAF will be a more conducive form of production for U.S. Steel due to its low-cost nature. As per WSJ:

In an electric furnace, steel is made by melting shredded up automobiles, refrigerators and other forms of scrap. "The EAF (electric arc furnace) can be started and stopped at will without exposing the mill to excessive costs associated with the shutdown or start-up process," says John Packard, publisher of Steel Market Update. It's also generally the less expensive option, especially with the higher iron ore and coal prices of recent years.

In addition, U.S. Steel also will construct a tubular products coupling facility at Fairfield, which will make couplings for its customers in the oil and gas industry, strengthening its oil country tubular goods (OCTG) segment. These operational improvements will allow U.S. Steel to improve its margins going forward.

U.S. Steel is a fundamentally weak company. It has a debt-laden balance sheet as its debt of $3.5 billion exceeds its cash position of $1.35 billion. In fact, U.S. Steel has one of the highest debt-equity ratios among its peers as shown in the chart below:

X Financial Debt to Equity (Quarterly) data by YCharts

Thus, the company has a highly-levered balance sheet, a result of which it will have to incur high interest expenses going forward. This will weigh on its margins and keep the bottom line under pressure. As such, it is not surprising to note that U.S. Steel's bottom line is expected to drop at an annual rate of almost 4% over the next five years compared to an expected increase of 2% for the overall industry.

U.S. Steel can benefit from an uptick in the construction and automotive segments in the U.S. The company supplies sheet products to construction companies, including both residential and non-residential. Now, both these segments are expected to do well this year. According to the 2015 Dodge Construction Outlook, U.S. construction starts in 2015 will increase 9% to $612 billion. This is almost double the rate of 5% that was seen last year.

The good thing is that the construction market will see growth across a variety of sectors, such as commercial, institutional and family housing. U.S. Steel looks well-positioned to make the most of this opportunity since it provides a wide range of products, ranging from siding and roofing components to HVAC systems. Thus, the integrated nature of U.S. Steel's business can help it attract more housing customers this year as demand in the end-market is expected to grow.

A similar pattern can be witnessed in the U.S. auto market, which seems headed for its best year since 2001, and U.S. Steel is trying to make good use of this opportunity by investing in the development of high-strength steels. Thus, the company is indeed trying to tap the opportunities on offer, and this could help it perform well going forward.

There's no shortage of threats that U.S. Steel faces. First, the company has to be wary of the influx of imports into the U.S. market, along with the strengthening of the dollar. This will allow foreign steel producers to flood the U.S. market with cheaper steel. As Bloomberg reports:

"Foreign competitors with weaker currencies pay less to produce the metal. That's allowing them to undercut U.S. steelmakers in their own backyard as demand wanes in China, Russia and Brazil.

The result: the amount of imported steel used in the U.S. has swelled in the first two months of 2015 to 33 percent from 28 percent in 2014, according to the American Iron and Steel Institute. At the same time, idled production capacity at U.S. mills has grown to 31 percent, the highest since 2009."

Hence, even though there's opportunity in the U.S. steel industry due to growth in certain key end-markets as stated above, U.S. Steel might find it difficult to compete against low-cost competitors. On the other hand, weakness in crude oil pricing has created pressure on U.S. Steel's tubular and flat-rolled segments. This is because energy companies have been forced to reduce their spending this year on infrastructure due to weak pricing, taking a toll on the business of steel companies.

This is another reason why the utilization rate of the steel industry in the U.S. has dropped in recent months as shown below:

At first, it looks like the strengths and opportunities are equally matched against the weaknesses and threats. U.S. Steel is doing the right thing by investing in EAF infrastructure, which will allow it to compete against low-cost imports and fight for a greater share of the auto and residential markets. At the same time, weak fundamentals and volatile energy prices are potent threats.

Finally, the company's valuation is a deal breaker. U.S. Steel trades at over 37 times last year's earnings, which is higher than Nucor's (NUE) multiple of 21 and Steel Dynamics' (STLD) multiple of 32. In addition, U.S. Steel's bottom line growth over the next five years is expected to be below both these companies. Hence, considering the different arguments presented above, U.S. Steel is a risky investment.

This article was written by

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