United States Steel Corporation (NYSE: X) delivered an above average 13.8% ROE over the past year, compared to the 6.1% return generated by the Materials sector. United States Steel’s results may indicate management is running an efficient business relative to its peers, which may very well be the case, but it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components may change your view on United States Steel’s performance and future prospects. I show you exactly what I mean in my DuPont analysis below.
How To Calculate United States Steel’s ROE
Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. Return on Equity or ROE is generally calculated using the following formula:
ROE = Net Income To Common / Average Total Common Equity
ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. However, it is important to note that ROE can be “manufactured” by management with the use of leverage or debt.
The return on equity achieved by United States Steel over the last few years is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of United States Steel has generally been increasing over the last few years. ROE increased from -52.7% to -18.7% in fiscal year 2016, increased to 13.8% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general improvement?
Understanding United States Steel’s Improving Return On Equity
The DuPont analysis is another way to calculate a company’s ROE using the following three metrics:
Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So what exactly is causing United States Steel’s improving returns?
Net Profit Margin Trends
It appears that the net profit margin of United States Steel has generally been increasing over the last few years. Margins increased from -14.2% to -4.3% in fiscal year 2016 and increased again to 3.2% in 2017.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at United States Steel’s efficiency performance to see if that is also boosting ROE.
Asset Turnover Trends
It appears that asset turnover of United States Steel has generally been increasing over the last few years. Turnover increased from 1.09x to 1.12x in fiscal year 2016 and increased once more to 1.29x in 2017.
source: data explorer – asset turnover
Therefore, the company’s increasing asset turnover ratio helps explain, at least in part, why ROE is also increasing.
Finally, the DuPont constituents that make up United States Steel’s ROE are shown in the table below. Note that the table also compares United States Steel to a peer group that includes Nucor Corporation (NYSE: NUE), Commercial Metals Company (NYSE: CMC), AK Steel Holding Corporation (NYSE: AKS) and Reliance Steel & Aluminum Co. (NYSE: RS).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that United States Steel’s general improvement in return on equity is the result of an improving net profit margin, an improving asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, United States Steel shareholders have reason to be excited due to the company’s general improvement in profitability along with a general improvement in operational efficiency and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. But before making an investment decision, I recommend you continue to research United States Steel to get a more comprehensive view of the company by looking at:
Efficiency Metrics: how much free cash flow does United States Steel generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.
Forecast Metrics: what is United States Steel’s projected EBITDA margin? Is the company expected to improve its profitability going forward? Analyze the company’s projected EBITDA margin here.
Risk Metrics: what is United States Steel’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.
Author: Andy Pai
Expertise: financial modeling, mergers & acquisitions
Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights:
- Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores.
- Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets.
Andy can be reached at email@example.com.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.