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Recession Fear And Margin Compression Will Keep US Steel Stock Depressed

Economic downturn and cash burn are key concerns for X stock

U.S. Steel (NYSE:X) stock has slumped by 43.3% this year. Further, the stock is lower by 77.5% since March 2018 highs of $46. Even after the big decline over the last 18 months, I believe that X stock should be avoided. This coverage will discuss the factors that are likely to keep the share price depressed.

Recession Fear And Margin Compression Will Keep US Steel Stock DepressedThere is little doubt that the global economy has decelerated in the last few quarters. The trade war between the United States and China has been one of the key factors for sluggish growth.

The spread between 2-year and 10-year Treasury yields has gone below zero for the first time since 2007. This is a strong recession indicator.

The likelihood of recession as predicted by the Treasury spread now stands at 31.5%, the highest level since 2007. Clearly, the United States is facing a downturn and this is negative for the steel industry.

The outlook is no better for Europe, with fears growing that Germany might slide into recession. According to the August PMI report, Europe is already in a manufacturing recession. If U.S. slowdown sustains, it is likely that the composite PMI falls below 50.

Additionally, China’s GDP growth is at the lowest level in three decades. Weak growth in emerging economies is bound to hit industries in the developed economy.

With key markets reeling under a slowdown and potential recession, X stock is unlikely to witness any bullish momentum.

Margin Compression Concerns

According to data compiled by Argus, U.S. hot-rolled coil prices declined fueled by economic skepticism. Further, futures traders are not expecting HRC prices to reach $600/st until October 2020.

For U.S. Steel, the EBITDA margin for second quarter of 2019 was 8% compared to 2Q18 EBITDA margin of 12%. It is very likely that deceleration in demand and decline in prices will translate into further margin compression.

The company caters to industries that include automobile, construction, mining, oil & gas and industrial. Weak economic growth would imply sluggish demand. Therefore, it would not be surprising to see revenue trend lower in-sync with weaker margins.

From the perspective of industries served, decline in sales in the automotive industry is a concern for the next 12-24 months. According to Boston Consulting Group, car sales are likely to fall by 9% to 15% in the United States by 2021. Even in the European Union, car sales are likely to decline by 5% to 10% by 2021.

U.S. Steel stock already has balance sheet cash that is at its lowest level in six years. As revenue declines and margins are compressed, operating cash flow will be impacted. Further, decline in cash is likely and will negatively impact X stock price.

It is also worth noting that the company’s net debt was $1,150 for the year ended December 2017. Net debt has increased to $1,764 million as of 2Q19. Clearly, cash burn is a concern and high leverage in uncertain times will keep investors away from the stock.

The positive point is that U.S. Steel has only $300 million in debt maturity until 2024. Therefore, there is no significant debt refinancing pressure. Debt servicing will not be a concern with annualized EBITDA likely to be in the range of $700 to $900 million. From a liquidity perspective, U.S. Steel also has $1.5 billion in undrawn credit facility and that adds to the liquidity buffer.

Final Words on U.S. Steel Stock

From a credit perspective, the company is still well positioned to service debt and manage debt maturities. However, the overall credit profile will weaken in the coming quarters on margin compression and lower operating cash flows.

It also remains to be seen if renewed expansionary monetary policies have the desired impact on economic growth.

The downside for U.S. Steel stock has been sharp in the last 18 months. The stock might not have another bout of sharp correction, but I see sideways-to-marginally lower movement rather than upside.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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