U.S. Steel (X) Rating Outlook Raised to Stable from Negative at Fitch

Fitch Ratings has affirmed United States Steel Corporation's (NYSE: X) Issuer Default Rating (IDR) at 'B+'. A full list of rating actions follows at the end of this release.

The Rating Outlook has been revised to Stable from Negative based on better than expected cost reductions, a more stable pricing environment, and Fitch's view that the market for oil country tubular goods has bottomed. China's supply side reform coupled with improving global demand supports improved pricing dynamics for steel producers. Trade protection coupled with infrastructure stimulus could further benefit U.S. producers. Even though Fitch expects modest declines in U.S. flat-rolled prices to follow declines in raw material prices in 2018 and 2019, profitability should improve with modestly higher volumes and better capacity utilization.

RECOVERY ANALYSIS

Fitch assumes a going concern EBITDA of $550 million compared to the Dec. 31, 2016 operating EBITDA of $401 million to reflect a recovery in flat-rolled pricing and volumes as well as modest improvement in tubular markets. For 2017, Fitch expects operating EBITDA of around $750 million.

Fitch assumes a reorganization multiple of 5x which generates a hypothetical going concern enterprise value of $2.8 billion. Fitch assumes administrative claims at $275 million or 10% of enterprise value. Fitch assumes the revolver is drawn to its $1.1 billion capacity.

INSTRUMENT UPGRADES

The recovery analysis indicates outstanding recovery for the secured credit facility and secured notes. Fitch upgraded the senior secured notes to 'BB+/RR1' from 'BB/RR2'.

The upgrade of the senior unsecured notes to 'B/RR5' from 'B-/RR6' reflects improved recovery after $51 million in additional pre-payment of unsecured notes and anticipated repayment of the $70 million IRBs due 2040 in April 2017.

KEY RATING DRIVERS

De-levering

Fitch expects annual operating EBITDA to improve to roughly $800 million on average for 2017 and 2018 with modest free cash flow generation. Fitch expects $285 million of debt to be repaid over the period. The combination of stronger earnings and debt repayment should drive total adjusted debt/EBITDAR to 4x and FFO adjusted net leverage to below 3x.

SUPPORTIVE TRADE COMMISSION ACTIONS

Fitch estimates import's share of U.S. domestic production fell to roughly 30% in 2016 from roughly 32% in 2015. Fitch expects further modest share gains in 2017.

In the U.S. duties have been imposed on imports of: corrosion-resistant steel from China, India, Italy and South Korea; cold-rolled steel from China, Japan, Brazil, India, South Korea, Russia and the United Kingdom; hot-rolled coil from Australia, Brazil, Japan, South Korea, the Netherlands, the United Kingdom and Turkey giving rise to import duties.

The European Commission has imposed duties on imports of: hot-rolled steel from China, heavy steel plate from China, seamless pipe and tube of non-stainless steel from China, and cold-rolled steel from China and Russia. Fitch expects U. S. Steel Kosice to operate near full capacity and have improved pricing power.

OCTG BOTTOMED

U. S. Steel Corporation is the largest domestic supplier of oil country tubular goods (OCTG) used in oil and gas drilling and the extreme curtailment in drilling activity in 2015 and 2016 resulted in a substantial OCTG inventory overhang and very low capacity utilization. In December 2016, the company decided to permanently close the Lorain #4, Lone Star #1 pipe mills, and the Bellville tubular operations. The Lone Star tubular operations were idled in April 2016. The slowdown backed into raw steel production with the blast furnace at Fairfield, AL permanently shut and steel making at Granite City, IL idled since December 2015. Fitch Ratings believes excess inventory represents less than six months and volumes and prices should improve beginning in the second half of 2017.

COMPETITION IN HOT-ROLLED

This commodity product accounted for 27.6% of 2016 the company's flat-rolled shipments and has faced significant competition from imports and mini mill producers. Lead times at mills are five weeks, limiting price appreciation to cost-push, mostly related to scrap prices. The remainder of flat-rolled production is higher value-added, with lead times more like eight weeks and mills are producing at capacity.

REDUCED BREAK-EVEN

U. S. Steel reported $745 million of Carnegie Way benefits in 2016 following $815 million in 2015, the bulk of which were in the flat-rolled group. Prior to this program, Fitch would have estimated break-even capacity utilization in the 67% to 70% range whereas the segment was profitable with average capacity utilization of 60%. The program for 2017 is also concentrated in flat-rolled manufacturing.

CONTROL OVER RAW MATERIALS

U. S. Steel benefits from ownership of iron mines and pellet and coke production facilities. In 2016, the company produced 4.5 million tons of coke and 17.6 million tons of iron ore.
U. S. Steel announced agreements to supply iron ore pellets to third parties over the next several years. The company restarted the Keetac pellet operations which were idled in May 2015 as a result of lower steel production. The company benefits from periods of high iron ore prices which tend to drive steel prices higher. Fitch expects iron ore prices to moderate to $55/tonne on average in 2017 to $45/tonne on average thereafter.

The company is exposed to coking coal markets and prices are expected to increase $19/ton for the 6.5 to 7 million tons consumed if domestic coke production and Suncoke Gateway operations run at capacity. European operations purchase coal with quarterly price resets and consumption is about 2 million tons annually at full coke making capacity. Fitch expects seaborne hard coking coal prices to average $165/tonne in 2017 dropping to $135/tonne in 2018, $120/tonne in 2019 and $110/tonne thereafter.

The company sources roughly 40% of scrap steel internally.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for U. S. Steel include

--Fitch expects revenues to rebound to roughly 2015 levels in 2017 and be relatively flat thereafter on improved prices and modest volume increases;
--Cost improvement and stronger revenues should result in EBITDA margins of about 7% on average in 2017 and 2018;
--Fitch expects capital expenditures to be in a range of $450 million to $475 million;
--Fitch expects debt to be repaid at maturity except for the $70 million IRBs due in 2040 to be paid in 2017;
--Fitch expects no change to dividend policy, no share-repurchases and no acquisitions over the next three years.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--Debt levels materially reduced;
--Free cash flow positive on average;
--Total adjusted debt/EBITDAR sustainably below 3.5x.

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 2017 and 2018;
--Weaker than expected operating results resulting in adjusted debt/EBITDAR sustainably above 4.5x;
--A debt financed recapitalization or debt financed acquisition. Fitch views this event as unlikely.

LIQUIDITY

At Dec. 31, 2016, pro forma for the redemption of the $70 million IRBs due 2040, cash on hand was $1.4 billion and availability under the revolver was $1.1 billion. Fitch expects U.S. Steel to be modestly cash flow positive over the next 24 months.

The stated maturity date of the $1.5 billion revolving credit facility is July, 27, 2020. The maturity date would be 91 days prior to the stated maturity of an issue of senior notes unless U. S. Steel has liquidity not less than $500 million plus the outstanding amount of such notes. The liquidity must include at least $300 million available under the revolver.

Maturities of debt over the next five years are $120 million in 2017, $165 million in 2018, $59 million in 2019, $435 million in 2020, and $1.2 billion in 2021.

In 2016, U. S. Steel bolstered its liquidity with $482 million in proceeds from equity issuance and stretched its maturities through the issue of secured debt, the proceeds of which were used to repay near-term maturities. In addition, the company contributed equity valued at $100 million to its pension funds.

FULL LIST OF RATING ACTIONS

Fitch affirms the following ratings:

United States Steel Corporation

--Long-term IDR at 'B+';
--Senior secured credit facility at 'BB+/RR1';

Fitch upgrades the following ratings:

--Senior secured notes to 'BB+/RR1' from'BB/RR2'.
--Senior unsecured notes to 'B/RR5'from 'B-/RR6'.

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