Commodities

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

One of the more painful, if rare, experiences for the CEO of a major corporation is when they suddenly leave and the stock price pops.

Klaus Kleinfeld, who last month lost the top job at Arconic Inc. (and most likely didn't get his ball back, either), had to also endure the market's reaction to the news -- namely a 3 percent increase in the share price.

Which brings us to United States Steel Corp., albeit from the opposite tack.

The steelmaker's ex-CEO Mario Longhi stepped down abruptly on May 8, though the market didn't learn of it until after the market closed on May 10. The stock fell the next day, and here is how it's done since the announcement as of Monday's close (versus some peers):

Exit, Pursued By Bears
U.S. Steel's shake-up at the top last week wasn't rewarded by investors
Source: Bloomberg
Note: Performance from close of May 10th through close of May 15th, 2017.

In this case, though, the drop in U.S. Steel's stock is as much of a Bronx cheer for Longhi as a pop would have been. That's a problem for his successor, David Burritt -- because, as it stands, U.S. Steel looks like a classic target for an activist shareholder.

U.S. Steel is plainly under significant operational pressure. Why else would a leading company in an industry that lives for cyclical upturns decide to embark on a multi-year overhaul of its facilities in the middle of one of those upturns?

Coil Spring
U.S. steel prices have recovered strongly from the slump in 2015
Source: Bloomberg
Note: Generic 1st month, hot-rolled coil steel futures contract.

As I wrote here, the mismatch between U.S. Steel's depreciation charges and capital expenditure suggest it is paying the price for underinvesting in its facilities. In a recent report, Novid Rassouli, an analyst at Cowen & Co., pointed out the mismatch has been even more severe in the core flat-rolled products division, which accounts for roughly three quarters of revenue:

Flattened
U.S. Steel seems to have underinvested in its core flat-rolled division, forcing it to catch up
Source: Cowen & Co.
Note: Ratio of capital expenditure to depreciation in U.S. Steel's flat-rolled division. Data for 2017 is a forecast.

Weirdly, U.S. Steel's cost per ton in the flat-rolled products division actually increased in the first quarter versus the prior quarter, by 14 percent, despite the fact that utilization also went up, by 8 percentage points. That is not how things are supposed to work; more utilization should mean fixed costs get spread over more tons of steel.

What compounds this, from the market's perspective, is a lack of clarity about what U.S. Steel is doing to fix the problems, how much it will cost, and how long it will take. A consistent theme during the Q&A on last month's woefully received earnings call -- when the stock dropped 27 percent in one day -- was confusion on the part of analysts. Longhi's dangling of the prospect of a protectionist tailwind for steel prices from the Trump administration was little help and, in light of the continuing turmoil at the White House, looks like an even shakier basis for a buy call.

Burritt was also on that call to defend the company's strategy, speaking several times about the need for "courage" to see it through. That view, along with the fact that Burritt joined the company in 2013 when Longhi was appointed CEO, likely explains why last week's reshuffle at the top didn't spark a rally. That's despite U.S. Steel's stock now trading at a wide discount to its peers:

Steel Cut
U.S. Steel's stock trades at a wide discount to its peers
Source: Bloomberg
Note: Enterprise value as a multiple of consensus forecasts for 2017 Ebitda.

If shareholders who paid $23 apiece in U.S. Steel's stock sale in August -- representing about 12 percent of the shares outstanding -- held onto them, then they may be feeling particularly nonplussed with their current 12.5 percent loss.

A low multiple; confusing messaging; operational headwinds; and a new CEO closely associated with the old regime: These are all things that would tend to draw an activist's attention (though nobody has chimed in yet).

While there may be no quick operational fix, an activist might well see an opportunity to do one key thing: reset the company's relationship with investors to rekindle support for a clearly communicated plan to overhaul U.S. Steel's portfolio.

Regardless of how that support is rekindled, it is of paramount importance. Without it, U.S. Steel's stock looks somewhat adrift. If the steel cycle proves to be kind, then the company's focus on rebuilding itself means rival stocks offer a cleaner way to play the rebound. If the cycle proves less supportive -- and reports of impending job cuts at Ford Motor Co. add to existing concerns about a key customer segment -- then there will be less of an earnings windfall to offset higher spending.

So investors might welcome an activist. And given what's happened to U.S. Steel's stock, taking a stake of 10 percent to become the largest shareholder would require cutting a check of just $350 million.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net