U.S. Steel Dropped to Underperform

On May 8, we downgraded U.S. Steel ( X - Analyst Report ) to Underperform factoring in the oversupply in the steel industry, pricing pressure, a still depressed construction market and the challenges faced by the company’s flat-rolled business.

Why the Downgrade?

The largest integrated U.S. steel producer posted, on Apr 30, a net loss of $73 million or 51 cents per share for the first quarter, narrower than net loss of $219 million or $1.52 per share recorded a year ago. Adjusted loss of 35 cents a share was wider than the Zacks Consensus Estimate of a loss of 18 cents.

Sales fell roughly 11% year over year to $4,595 million, missing the Zacks Consensus Estimate of $4,612 million. U.S. Steel faced continued economic challenges and competitive steel market conditions in the quarter.

While U.S. Steel should benefit from increased cokemaking capabilities and healthy automotive demand, it continues to contend with challenging steel market fundamentals.

Current trends in the steel industry are not quite inspiring. Oversupply in the industry has led to a decline in steel prices as Chinese steel production has outpaced demand. Oversupply and increased domestic imports represent headwinds for U.S. Steel.

Macroeconomic concerns and a still sluggish construction market are still weighing on U.S. Steel’s prospects. Pricing in Europe remains under pressure due to the sovereign debt crisis and weak demand.

U.S. Steel is also exposed to risks concerning pricing and availability of raw materials. The company expects raw material (iron ore) costs to rise in its European operation in the second quarter, thereby impacting results.

Moreover, higher costs are expected to hurt the company’s flat-rolled business in the second quarter. U.S. Steel envisions operating costs to increase as a result of higher repairs and maintenance costs and higher natural gas costs. Our view reflects these concerns.

U.S. Steel currently carries a short-term Zacks Rank #5 (Strong Sell).

Steel Stocks That Warrant a Look

While we prefer to stay away from U.S. Steel, other companies in the steel industry having favorable Zacks Rank are Angang Steel Company Ltd ( ANGGY ) , LB Foster Co. ( FSTR - Analyst Report ) and Ternium S.A. ( TX - Snapshot Report ) . All of them hold a Zacks Rank #2 (Buy).