Shares of steelmaker AK Steel Holding Corporation (NYSE:AKS) finished the day up 12.4% on July 25, following the release of the company's financial and operating results for the second quarter, reporting revenue and profits that both beat Wall Street analyst expectations.
In short, the market is quite pleased with AK Steel's $1.56 billion in revenue, better than the consensus $1.53 billion estimate, and earnings of $0.19 per share, well ahead of the market's $0.13-per-share outlook.
The interesting thing about AK Steel's results is that the company made more revenue and higher profits while selling and producing less steel. According to the earnings release, the company shipped 1.47 million tons of steel in the quarter, compared with 1.56 million tons in the year-ago quarter. Through the first half of the year, tonnage shipped has fallen 8%.
This is at least in part by design, but also due to weakness in an industry AK Steel relies heavily on. According to CEO Roger Newport, the company's strategy to focus on higher-margin products has caused volumes in some categories to fall, but the biggest reason for the volume decrease was weaker demand from the U.S. automakers. Auto sales have been in decline in recent quarters, after reaching a cyclical peak about a year ago. Factor in a recent increase in imported steel -- much of which industry insiders say is illegally subsidized by its country of origin -- and there are near-term pressures that could raise challenges for AK Steel.
AK Steel, like most of its peers in the North American steel industry, have struggled with high levels of imports taking market share even as domestic steel consumption has been relatively high. AK has also struggled with high fixed costs for years and has only recently begun implementing a strategy to bring its costs down, while also focusing on improving its balance sheet.
This has started to pay off, as this quarter's result showed, with higher prices on high-margin products more than offsetting lower volumes. Furthermore, the U.S. economy has continued to show relative strength, which should at least support steady demand for steel.
That's where the good news mostly ends for AK Steel, and this is the most important thing investors should consider before buying shares of the company: The company has made progress on improving its operations, lowering costs, and deleveraging its balance sheet, but it's heavily tied to the automotive industry -- and is increasing that exposure with the acquisition of automotive supplier Precision Partners.
This creates a situation of almost binary risk for investors, where the company could do extremely well if domestic auto sales recover from the current slowdown, but it could also see its cash flows and profits get hammered if demand continues to weaken.