When investors think about the domestic steel market, the name United States Steel (X 0.45%) comes to mind. That's largely because of the company's iconic history since it is no longer the leading steel name in the country, a designation belonging to its peer Nucor (NUE 1.63%). While U.S. Steel had a great year in 2021, investors should think twice before jumping aboard today -- even though this company is trying to look more like industry-leading Nucor. Here's what you need to know.
The old ways
U.S. Steel's history traces back to the early days of the steel industry in the United States. It's a great story, but it includes an important caveat: The steel mill's history comes out of the blast-furnace era. This is an older way of making primary steel and requires strong operating volumes to be profitable. When demand is high, blast furnaces can generate huge cash flows. However, when demand falls and mills are operating well below their capacities, they can bleed mountains of red ink.
This is a problem for steel mills because steel demand is highly cyclical, ebbing and flowing with economic growth. On the other hand, Nucor started making steel much later and uses electric arc mini-mills. This technology is far more flexible, uses scrap steel, and allows Nucor to ramp its production up and down more easily and profitably. Downturns hurt performance, but Nucor generally remains profitable in all but the severest recessions. Of course, there are other important differences between these two companies, but the basic technology is a core issue.
To its credit, U.S. Steel isn't ignoring the problem. It has begun building or buying electric arc mini-mill assets. The goal is to create a balance between making primary steel using blast furnaces and expanding into scrap-based mini-mill production. The basic idea is to help smooth out the company's performance over time. It is a good idea -- primary steel is still necessary, even though scrap steel is plentiful. The problem for U.S. Steel is that the continued blast-furnace exposure means its results will remain highly exposed to downturns.
This is not a sea change
That's where 2021 starts to come into focus. U.S. Steel's top line increased from $9.7 billion in 2020 to $20.3 billion in 2021. The company went from a generally accepted accounting principles (GAAP) loss of $5.92 per share in 2020 to a profit of $15.77 per share in 2021. Notably, mini-mill shipments went from zero in 2020 to roughly 14% of the total in 2021.
To highlight just how good things were, the company was happy to report that its earnings and free cash flow were at record levels. That's good news but not really shocking. The economic upturn has resulted in material steel demand and rising prices across all the company's divisions. Add in the nature of the blast furnaces that underpin its operations, and it makes complete sense that 2021 was a very good year. Indeed, 2021 was good for Nucor, too.
The difference is that when demand starts to fall and steel prices get weak, U.S. Steel is likely to see its margins crater and -- despite the new mini-mill assets it owns -- turn negative. Nucor's history suggests that it will better handle the eventual downturn because its steel mills are more flexible mini-mills.
Not if, but when
When times are good in the steel industry, U.S. Steel's stock often outperforms Nucor's shares -- that's because investors seek a more leveraged play on a steel rally. But the good times in this industry are invariably followed by bad times, during which U.S. Steel's performance and stock are likely to lag behind peers like Nucor that operate more modern and flexible mills. Someday, U.S. Steel may have a more balanced portfolio, but most investors would still be better off with Nucor if they want to invest in a steel company today. That said, a better bet would probably be to wait for the next industry downturn when you can buy Nucor on the cheap.