NEW YORK--Fitch Ratings has downgraded United States Steel Corporation's (U.S. Steel; NYSE: X) Issuer Default Rating (IDR) and senior unsecured debt ratings to 'B+' from 'BB-'. The senior secured credit facility has been affirmed at 'BB+/RR1' A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The Rating Outlook has been revised to Negative. Improvement in earnings and cash flow will require better oil prices and a reduction in import competition. While Fitch expects trade cases to result in a reduction in the market share of imports and views current oil prices as unsustainably low, visibility into the timing of the recovery is limited.
Lower rig counts have hit the company's oil country tubular goods volumes and import competition and weak iron ore prices have filtered through to lower steel prices which lowered earnings expectations. Tubular shipments for the year through Sept. 30, 2015 were 465,000 tons compared with 1.3 million tons in the year through Sept. 30, 2014. Flat-rolled prices averaged $674/ton in the third quarter compared with $772/ton on average for the full year in 2014.
Hard freeze of the pension fund, capacity closures, more efficient raw materials sourcing, and better working capital management have benefitted earnings and cash flows but not enough to offset the impact of weakening demand and global overcapacity.
Imports have been very strong given very high relative prices in the U.S. combined with global over capacity. Steel demand related to oil country tubular goods has fallen with the drop in oil prices contributing to the modest decline in overall consumption despite strong demand from autos, appliances and construction. Capacity utilization was 72% on average for the year through November 2015. Fitch Ratings believes that margins are vulnerable when capacity utilization is below 80% and that capacity utilization could remain below 80% through 2016.
The domestic steel market has shown supply discipline, but global overcapacity and lack of discipline elsewhere has limited pricing power. Increased supply of iron ore and coking coal coupled with slower growth in steel production has resulted in raw materials deflation.
As of Dec. 31, 2014, the defined benefit pension plans were underfunded by $966 million on a GAAP basis. Re-measurements as of Sept. 30, 2015 increased the underfunding by $295 million. Pension and other post-employment benefit costs were $312 million for 2014 and cash payments were $545 million including the $140 million voluntary contribution to the main U.S. defined benefit pension plan. Costs for 2015 are expected to be $245 million and cash payments are expected to be $300 million. U.S. Steel has no mandatory contribution requirement for its main U.S. defined-benefit pension plan in 2015.
The ratings reflect U.S. Steel's leading market positions in flat-rolled and tubular steel in the U.S., together with its high degree of control over its raw materials offset by the high fixed costs of integrated steel producers.
U.S. Steel is the second largest North American flat-rolled steel producer with capacity of 19.4 million tons; 2014 shipments were 14 million tons. U.S. Steel is the largest integrated North American tubular producer, with capacity of 2.8 million tons; 2014 shipments were 1.7 million tons. U.S. Steel also operates a five million ton per year integrated steel operation in Kosice, Slovakia.
U.S. Steel's production of iron ore pellets including from its share of joint ventures was 25 million tons in 2014, accounting for a significant share of its needs. In 2014, North American raw steel produced was 17 million tons and, assuming 1.3 tons of iron ore pellets are needed to produce 1 ton of raw steel, 22 million tons of iron ore pellets were consumed.
--Fitch expects 2015 to be a trough year for domestic flat rolled and tubular products with modest improvement in 2016 and 2017;
--Fitch expects capital expenditures at guidance in 2015 and at maintenance levels in 2016;
--Pricing is expected to improve modestly in 2016 and 2017 but Fitch believes upside is limited given global over supply. For 2016, Fitch Base Case price assumptions are $680/ton for the Flat-rolled product segment, $1,445/ton for the Tubular segment, and $545/ton for the U.S. Steel Europe Segment;
--Cost improvement is anticipated with Carnegie Way initiatives.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Deterioration in liquidity coupled with cash burn greater than $300 million in aggregate in 2016 and 2017;
--Weaker than expected operating results, whether from lack of recovery in tubular demand or from unfavorable resolution of trade cases, resulting in adjusted debt/EBITDAR sustainably above 4.5x.
--A debt financed recapitalization or debt financed acquisition. Fitch views this event as unlikely
Positive: Future developments that may lead to a positive rating action include:
--Debt levels materially reduced and free cash flow generation that is expected to be positive on average.
--Faster than expected turnaround in market dynamics allowing positive free cash flow generation.
--Total adjusted debt/EBITDAR sustainably below 4.0x
LIQUIDITY AND DEBT STRUCTURE
U.S. Steel generated operating EBITDA of $665 million with negative free cash flow of $22 million after $230 in gross interest, capital expenditures of $546 million and dividends of $29 million in the latest 12 months ended September 30, 2015. Pro forma for the redemption of the $316 million in convertible notes to be repaid, as of Sept. 30, 2015, cash on hand was $849 million; total debt was $3.2 billion; and the $1.5 billion facility maturing in July 2020 was undrawn. The facility has a 1.00:1.00 fixed-charge coverage ratio requirement only at such times that availability under the facility is less than the greater of 10% of total commitments. Fitch expects U.S. Steel to burn about $200 million in free cash flow in 2016.
At Sept. 30, 2015, total debt/operating EBITDA was 5.25x. Fitch expects the company will make its revised EBITDA guidance of $225 million in 2015 and will earn about $389 million in EBITDA for 2016 resulting in very high leverage. With partial recovery in shipments and modest pricing improvement, Fitch expects EBITDA to approach mid-cycle levels of about $1 billion in 2017 dropping leverage to below 4x by the end of 2017. Near-term scheduled maturities of debt are $45 million in 2016, $500 million in 2017, $503 million in 2018 and $58 million in 2019.
FULL LIST OF RATING ACTIONS
Fitch has taken the following actions:
United States Steel Corporation
--Long-term IDR downgraded to 'B+' from 'BB-';
--Senior secured credit facility affirmed at 'BB+/RR1';
--Senior unsecured notes downgraded to 'B+/RR4' from 'BB-/RR4'.
The Rating Outlook has been revised to Negative.
Additional information is available at 'www.fitchratings.com'.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 07 Dec 2015)
Dodd-Frank Rating Information Disclosure Form