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1 Steel Stock to Buy, 1 to Avoid

Steel Dynamics (NASDAQ: STLD  ) offers investors a strong pipeline of growth projects, solid margins, and a diversified product mix compared to its peer AK Steel (NYSE: AKS  ) , which continues to struggle and is expected to generate little free cash flow in the near future, driven by substantial pension and OPEB obligations.

Steel Dynamics started the steel companies' earnings season last week with in-line quarterly results. The company reported 1Q14 adjusted operating EPS of $0.16, in-line with consensus estimates of $0.16. The headline EPS of $0.17 included a $0.01 benefit from changes to Indiana's corporate tax rate. The results were at the top end of the company's $0.13-$0.17 guidance range released last month.

As expected the quarterly results were severely affected by poor weather, high natural gas, transportation disruptions, and power curtailments. However, these were unusual circumstances and all these factors should normalize going forward. Some steel which is already sold to the customers was unable to be shipped to customers due to transportation constraints from the mills. However, this will be shipped over the coming months.

Benefits from recent disruptions in the market
Steel Dynamics' Butler mill is in close proximity to U.S. Steel's (NYSE: X  ) Gary Works and Great Lakes Works facilities, both of which are currently experiencing disruptions. At Butler, STLD is planning to ship some substrate material to the Techs in 2Q which they believe will provide a cost advantage compared to other sources of supply given some of the recent disruptions in the market. The company's order book is currently full through May and will open by the end of April or early next month for June. Keeping in mind outages at company's competitors, the order book for June should fill up quickly as well. All this should help the company improve Q/Q flat-rolled shipments meaningfully.

Positive demand outlook
Steel Dynamics is looking at strong second quarter results as the demand supply conditions shape up to offer an opportunity for the company to recoup first quarter weakness. Moreover, supply disruptions among peers may create some short-term market share opportunities for Steel Dynamics. The company remains optimistic in gradually improving steel demand. Steel Dynamics' Fabrication segment is also seeing strong inquiries and bookings, indicating continued recovery in the non-residential market.

AK Steel
AK Steel, on the other hand, reported a bigger quarterly loss than expected. The steel maker reported 1Q14 quarterly loss of $0.59, missing Wall Street estimates of -$0.43 by a huge margin. It was a noisy quarter as adverse weather, both planned and unplanned outages, and a messy tax line all affected results negatively.

A combination of factors, including $18 million for the Ashland Works blast furnace outage, $27 million in increased energy costs, and $28 million in accelerated planned maintenance costs led to weak adjusted EBITDA performance of $2 million for the quarter. In a normal environment, adjusting for all these factors, the company would have generated $75 million of EBITDA.

But look at the complete picture
While the market may give AKS a weather pass, it is important to note here that these issues were already highlighted by the company when it released its quarterly guidance last month. Moreover, even after excluding the adverse impacts of non-recurring items, the company would still have been making a loss.

Furthermore, while the cold winter affected volumes and drove energy costs higher, it also affected scrap supply that drove up domestic steel prices well above international markets. So we need to look at the complete picture and not just the cost headwinds that the company faced during the quarter.

AK Steel's results should improve sequentially, driven by higher sales prices, better demand, and a lighter cost burden. Not only there will be fewer non-recurring expenses, the $70 million of full-year 2014 coal and coke cost savings will also begin to flow through the income statement next quarter. However, these sequential improvements are already priced in the stock as the company had previously provided a clear path to cost improvements in 2Q14. What the market may be underestimating is the impact on AK Steel of iron ore shipment delays in the Great Lakes, which are constraining blast furnace capacity and limiting its ability to capitalize on current spot market opportunities.

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  • Report this Comment On April 23, 2014, at 1:28 PM, notbearish wrote:

    wha's your thought on the import duties on electrical steel mentioned in the aks cc?

  • Report this Comment On April 24, 2014, at 3:20 AM, Interventizio wrote:

    I've recently sold MT: one of your articles warned me that the future of automotive could be alluminium cars. That'd be a huge hit for the steel industry.

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Jan-e- Alam

Jan-e-Alam writes mostly for the Motley Fool energy and materials sector. He has been writing for several financial media websites for a few years now and other than materials/energy sector also covers financials and industrials. He holds an undergraduate degree from Loughborough University and is a CFA Level III Candidate. He has also worked for a bulge bracket bank in the past.

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