3 Reasons U.S. Steel Stock Could Fall

U.S. Steel is seeing nascent signs of a market upturn, but if it doesn't take shape the shares could head lower.

Aug 20, 2014 at 11:24AM

There are positive signs in the U.S. steel market that could lead to an upbeat future for U.S. Steel (NYSE:X) and its shareholders. However, if economic growth stalls so too could U.S. Steel's prospects.

Sensitivity training
Steel is a key material in economic growth. You can't put up buildings without it, or put cars on the roads (let alone build roads). And our modern households are filled with steel from the kitchen stove to the fridge. That's why global steel demand skyrocketed when China's gross domestic product was growing in the mid-teens as recently as 2007. The massive steel demand led prices higher everywhere and helped push U.S. Steel's profits to nearly $18 a share in 2008.

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(Source: CIA)

However, the 2007 to 2009 global recession put a stop to that. Not only did China's growth quickly slow into the high single-digits, but the United States, which is U.S. Steel's main market, fell into an economic funk. While growth has resumed, it has been subdued at best. In fact, the World Bank only expects the United States to grow by around 2.1% this year. That, however, is better than Europe, another key U.S. Steel market, which is only tagged to grow by 1.1%.

And while China is expected to grow a far more robust 7.6%, that's well off the 14.2% GDP growth achieved in 2007 and won't be helping to push global demand higher. No wonder U.S. Steel has been bleeding red ink for five consecutive years. In that span shareholders have seen a cumulative loss of roughly $26.50 a share.

The point being, if global growth takes another nose dive U.S. Steel's shares are likely to go down with it. And for good reason.

Tap-on effects
China's slowdown has a more meaningful impact than it might at first seem for a company that's more focused on the United States and Europe. That's because steel production around the world ramped up to sate China's growth-driven appetite. Without as much consumption in China, mills around the world are looking for places to sell their wares at any cost. And the United States is a favorite locale.

In fact, major U.S. steel makers like U.S. Steel, AK Steel (NYSE:AKS), and Nucor (NYSE:NUE) are all vocally complaining about imports being sold below the cost of production. That's known as dumping, and Nucor's CEO and CFO have targeted the combination of overcapacity and dumping as "the biggest risk" to the steel industry.

(Source: Bmpeters, via Wikimedia Commons)

How big an issue is this for U.S. Steel? Although the oil drilling industry in the States is in the midst of a renaissance, U.S. steel expects only a modest improvement in this business in 2014 because of competition from low-priced imports (which make up about half the market).

Costs matter
This is why keeping costs in check is so important for U.S. Steel. The company has done an enviable job of controlling costs; it is self sufficient, or nearly so, with regard to key inputs iron ore and coke. But it's still on the high end of the cost curve.

That's because U.S. Steel uses blast furnaces, an older and more expensive technology. And while an improving industry outlook will lead to a swift increase in profitability once U.S. Steel covers its mill costs, if the economy falters or imports restrain prices, red ink will continue to flow.

It could go either way
U.S. Steel is doing the right things to survive this industry downturn. However, that doesn't change the fact that a solid economic recovery has to take place for the company to really turn the corner. That will, eventually, happen. But with economic growth limping along in so many places, including the United States, it's hard to rule out another downturn. That, coupled with high costs and foreign imports, would likely lead to more near-term weakness for U.S. Steel and its shares.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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