As the global economy speeds up, automotive sales are kicking into a higher gear. Despite new materials such as carbon fiber, carmakers still prefer steel. That’s good news for Ohio-based AK Steel Corp. (AKS.N), a market leader focusing on innovation and quality.
Steel allows automakers to craft lighter-weight vehicles without compromising affordability, strength, safety or performance, according to research firm IHS.
The outlook for annual car production in the U.S. is 16.8 million for 2014, 17 million for 2015, 17.5 million for 2016 and 17.8 million in 2017. In the first quarter of 2014, steel imports by U.S. companies increased 36% on the year to 10.6 metric tons, the highest since 2006, according to Global Trade Information Services. What’s more, domestic weekly production has hit or exceeded one million net tons of raw steel in the period.
Market Leaders
AK Steel Group generates more than 50% of its total sales from the automotive industry, supplying Ford, GM, Chrysler, Honda, Mercedes-Benz, BMW, Nissan and Toyota. Given the upward trend in the carmaking sector, AK Steel is comfortably positioned to expand its market share.
During Alpha Deal Group’s initial due diligence call, Assistant Treasurer Douglas Mitterholzer said the company, which specializes in manufacturing advanced high-strength steel, coated steels, chrome stainless steels and stainless sheet and strip steels, as well as electrical steels, will continue to focus on innovation in order to be able to offer its clients with better, stronger products and maintain its position as supplier of high-quality steels.
The company has a leading position in the carbon coated steel segment. It is the biggest U.S. producer of chrome stainless steels for high-temperature and corrosion resistant exhaust auto components and a global leader in the production of electrical steel used in the manufacturing of energy-efficient transformers for power generation and distribution.
Automotive Powers Growth
The carmaking industry is the biggest growth driver for AK Steel due to its large market share. Increasing demand is already starting to be felt, with the company’s steel shipments to automakers for Q1 2014 at the highest since 2007, even though overall steel shipments in the quarter were lower both on a sequential and annual basis.
March light vehicle production hit 1.53 million, translating into an annualized sales rate of 16.3 million, an increase by one million cars compared with 2013. This has led to a significant increase in the demand for the company’s coated and cold-rolled carbon steel products, as well as its range of stainless steel products.
Other growth drivers for AK Steel include the recovery of the U.S. housing market as well as the economic pickup in Europe. In addition, stricter efficiency standards are driving innovation and presenting an opportunity for the company to make the best of its advanced R&D department. In addition, the electrical steel market is also shaping up positively in spite of a considerable surplus in production capacity around the world. AK Steel’s electrical steel shipments in the first quarter, however, were higher than projected, although they were lower than in the previous quarter and the first quarter of 2013.
Q1 Financials
AK Steel reported a net loss of $86.1 million for Q1 2014, or $0.63 per diluted share, on sales of $1.38 billion. The average price for its steel in the period stood at $1,096 per ton, up 3% on the year and up 6% on a sequential basis.
The net loss in Q1 2013 was $9.9 million, or $0.07 per diluted share. For the last quarter of 2013, the company booked a net profit of $35.2 million or $0.26 per diluted share. Adjusted EBITDA for Q1 2014 was a negative $2.8 million, against a positive result of $66.8 million for the first quarter of 2013 and $87.2 million for the fourth quarter of last year.
AK Steel share price
Source: Eikon/StarMine
Unforeseen charges
The weak results were attributable to four events, including an unplanned outage at the company’s Ashland Works blast furnace in late February which cost it $18 million. Planned outages in the three-month period added $29.4 million to the bill, significantly higher than the $1 million spent on planned outages in the first quarter of 2013 and the $1.5 million from the last quarter of the year. However, the Q1 2014 figure included most of the maintenance activities at Ashland Works planned initially for the second quarter of the year. AK Steel said it doesn’t plan any more significant outages until the end of the year.
Another contributing factor was the harsh winter, which pushed up energy costs at the company’s plants significantly. Between January and March 2014 these were $30 million higher than in Q1 2013 and $27 million higher than in Q42013. There were also higher costs for iron ore and carbon scrap plus a $5.8 million charge related to a litigation settlement which is still awaiting court approval.
AK Steel financial strength
Source: Eikon/StarMine
Liquidity boost
Figures for the first quarter of 2014 also included a LIFO credit of $1.5 million, down from $6 million for the corresponding quarter of 2013 and $4.3 million in the last quarter of the year. Liquidity at the end of March stood at $787 million. Also during that quarter AK Steel took on a revolving asset-backed credit facility maturing in 2019 to the total amount of $1.1 billion, replacing an earlier facility of the same type that would have expired in spring 2016. The new facility, according to the company, will boost its liquidity and make it more strategically and operationally more flexible.
Competition and Risks
Although steel demand is improving, excess production capacity worldwide is pressuring prices. Output outside the U.S. also seems to be in surplus, as evidenced by the considerable increase in imports over the first three months of the year, which led to loud complaints from U.S. steelmakers. However, they are unwilling to push for the introduction of import tariffs as they could not effectively counteract China’s huge steel production capacity. This situation introduces some volatility in the steel industry but it is unclear to what extent if at all it could offset reviving demand.
Locally, AK Steel competes with United States Steel Corp. (X.N), which specializes in flat-rolled and tubular steel products but also pursues other business such as railroad and barge transportation and building construction. While such diversification allows for better risk distribution, AK Steel’s focus on innovation and the development of new, more competitive products gives it a competitive edge resulting from its consistently high quality.
Outlook and Strategic Goals
AK Steel’s management is optimistic about the near term, confident about its solid position in its core automotive market and the improving economic situation around the world in general and in the U.S. specifically.
The company is now planning to focus on cutting costs by increasing its self-sufficiency with regard to raw materials, Mitterholzer said at the end of the call. It has already achieved its targeted self-sufficiency rate of 15% for power consumption, 100% for carbon slabs and 90% for coke, and is now working toward achieving a self-sufficiency rate of 50% for coal and the same for iron ore, the former depending on the market price for coal and the latter to be accomplished via subsidiary Magnetation LLC.
This will have a substantial effect on costs, according to the company, and will contribute to the more efficient use of capital. Total investments in coal and iron ore self-sufficiency are almost $400 million and annual benefits from the iron ore program alone are seen at $60 million to $130 million. In light of our initial due diligence, we view this as ideal entry point for long-only value market players.
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