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Our ratings on the company also reflect its "strong" liquidity, good scope and breadth of product and operations, and the benefits of its backward integration into iron ore and coke production.
Domestic steel demand and prices have fluctuated significantly over the past few years. But, overall, U.S. Steel's financial performance has gradually improved because of better auto production and solid demand for oil country tubular goods. However, metrics still remain weak as global economic conditions and domestic oversupply weigh on pricing. As of Sept. 30, 2012, debt to EBITDA improved to 5.4x from 6.2x the prior year and funds from operations (FFO) to total debt was about 13% in each year. (We adjust these measures for post-retirement obligations, operating leases, and asset retirement obligations.) However, steel pricing has been following a similar pattern to the past several years, with prices firming up in the first half and weakening at mid-year, so we would expect some further weakening by year end.
We now expect 2012 EBITDA to be closer to 2011's $1.3 billion, with credit metrics weaker than what we consider appropriate for the 'BB' rating. We believe debt to EBITDA in 2012 will approach 6x, and FFO to total debt could fall to 10% compared with the our expectations for the rating of debt to EBITDA of about 4.5x and FFO to debt of about 20%. However, in our view, we expect conditions to improve somewhat in 2013, reflecting our expectation for continued slow growth in the U.S. economy and lower raw material costs. However, if persistent domestic overcapacity because of slower-than-expected U.S. economic growth, economic uncertainty in Europe, and slowing steel usage in China continue to pressure pricing and margins and erode liquidity, and we do not see improvement in credit metrics in the first half of 2013, we could lower the ratings.
U.S. Steel is a relatively large player in the highly fragmented global steel market. It has about 24 million tons of steel capacity in North America and about 5 million tons of capacity at its operations in the Slovak Republic. U.S. Steel is also the only integrated steel company in North America that is primarily self-sufficient in producing iron ore and produces and has long-term contracts for a majority of its coke needs, which has somewhat limited its exposure to recent rapid increases in procurement costs. It also has a diverse product mix that is mostly value added. It's a leading domestic producer of tubular products (for the oil and gas industry) and tin and other coated-steel products. However, it is significantly exposed to the volatile flat-rolled market, with spot sales accounting for about half of its total shipments.
In our view, U.S. Steel's liquidity is strong. Relevant aspects of our assessment of the company's liquidity profile include:
-- We expect sources of liquidity to exceed uses by 1.5x or more for the next couple of years;
-- The company is likely to be able to absorb high-impact, low probability events without refinancing; and
-- The company's maturities are manageable--the next significant maturity is for its $863 million senior convertible notes in 2014, which we would expect the company to address in the coming year. As of Sept. 30, 2012, the company had about $2.5 billion in available liquidity, including $536 million in balance-sheet cash and full availability on its $875 million revolving credit facility due 2016, which is secured by inventory. The facility has a springing fixed-charge covenant of 1x if availability falls to less than $87.5 million. U.S. Steel also has the full amount available under its $625 million accounts receivable securitization program that expires in 2014 and about $361 million available on European credit lines.
For the 12 months ended Sept. 30, 2012, U.S. Steel's cash from operations was about $1 billion, which was used to fund about $760 million of capital spending. We expect capital expenditures at similar levels in the coming year as the company continues to invest in strategic projects, including construction of new coke and coke substitute production facilities and upgrades to its tubular business. As a result, we expect the company to be free cash flow negative in 2012, excluding asset sales, and unless market conditions improve, cash flow is likely to be negative in 2013 as well. We do not expect the company to significantly increase its dividend, which it reduced to $0.05 per share from $0.30 per share, or to repurchase shares in the coming months, given still relatively weak operating conditions and credit measures.
For the complete recovery analysis, see our recovery report on U.S. Steel, published April 2, 2012, on RatingsDirect.
The negative rating outlook reflects our expectation that U.S. Steel's financial risk profile and credit measures are likely to be weak for 2012 and the first part of 2013. In 2013, U.S. Steel may only generate about $1.3 billion of EBITDA, with credit metrics below our expectation for the rating. In our view, continued slow economic growth in the U.S. and relative strength in the company's key end markets should lead to better performance in 2013. The rating also reflects our view of the company's strong liquidity, which should be sufficient to fund increased working capital needs as business expands and as capital spending remains high to fund strategic projects.
We could lower the rating if industry conditions continue to be weak in early 2013 and show few signs of near term improvement and we do not see credit metrics strengthening--leverage below 5x and FFO to total debt above 15%--by year end 2013. In addition, we could lower the rating if economic and political uncertainty throws the economy into recession or causes weak industry conditions, resulting in the company's liquidity falling below $1 billion as it uses its available funds to cover operating losses.
An upgrade would be contingent on a sustained improvement in market conditions, allowing the company to improve its debt to EBITDA to less than 3x and FFO to total debt to more than 30% on a sustained basis. We do not view this scenario to be likely over the next 12 months.
Related Criteria And Research
-- Key Credit Factors: Methodology And Assumptions On Risks In the Metals Industry, June 22, 2009
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008