Don't Pay Too Much Attention to Steelmakers' Warnings

The first quarter was a tough one for steelmakers, as harsh winter weather raised costs and delayed shipments. AK Steel's (NYSE: AKS  ) CEO James Wainscott even said, "thank goodness it's behind us" during the first quarter earnings call. Steel Dynamics (NASDAQ: STLD  ) blamed weather conditions for reduced earnings, as cost rose due to higher electricity and natural gas costs. Nucor (NYSE: NUE  ) and U.S. Steel (NYSE: X  ) were hit by the weather as well.

It turns out that steelmakers' problems did not end in the first quarter. AK Steel recently issued its second quarter guidance, stating that it expected to report a net loss of $0.19 to $0.23 per share. This number is a disappointment, as analysts were hoping that the company would be able to score a profitable quarter.

Nucor's guidance was also soft. The company stated that its second quarter earnings would be in the range of $0.35 to $0.40 per share, at the low end of its own guidance and below analysts' consensus estimates. However, it doesn't look like the issued guidance changes the outlook for AK Steel and Nucor.

AK Steel's adjusted loss will be much lower
Importantly, most of AK Steel's projected loss consists of a $0.17 per share loss due to mark-to-market losses on derivatives. This hedging loss is unrealized, and the company could record a gain on its hedge position going forward, which will offset this loss. Without this loss, AK Steel's second-quarter loss will be $0.02 to $0.06 per share. Both numbers are way better than they were in the first quarter, when AK Steel reported a loss of $0.63 per share and an adjusted loss of $0.40 per share.

Meanwhile, shipments rose 9% from the first quarter numbers, reflecting the improvement in weather conditions. AK Steel also stated that pricing remained flat. At first glance, this might seem like negative news for other steelmakers like U.S. Steel or Steel Dynamics, as steel prices are at depressed levels. However, as the steel market continues to be oversupplied and is pressured by cheap imports, the fact that the price did not deteriorate further is a positive.

Nucor: fairly valued?
Nucor's second quarter earnings will likely be in-line or slightly above first quarter earnings, which is rather a disappointment. However, the fact that Nucor will have a hard time showing growth in current conditions is not a big surprise.

The company's relatively low leverage, strong balance sheet, an almost 3% yield and a history of profits support its shares. However, all these advantages are already reflected in Nucor's shares, which trade at a premium to peers. In order to have more upside, Nucor must deliver strong earnings growth, which is difficult to accomplish in the current price environment.

Bottom line
Steelmakers' earnings warnings don't change the big picture. As shipment problems transferred into the second quarter, the second half of the year will be busier for the industry. Yet, the companies must be able to catch up with shipments by year-end.

At current prices, AK Steel remains cheaply valued as it trades at a discount to peers while showing decent performance in today's tough market. Nucor, on the other hand, looks fairly valued and lacks upside catalysts.

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Vladimir Zernov

Vladimir Zernov believes that fundamental analysis works best with energy and materials stocks and covers them on Motley Fool.

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8/28/2015 4:00 PM
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