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AK Steel in Good Shape Despite Soft Guidance

By Vladimir Zernov – Mar 26, 2014 at 8:36AM

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AK Steel is on the right track despite the expected first quarter loss.

The fourth quarter of last year looked like a breakthrough for AK Steel (AKS), as the company finally returned to profitability. However, AK Steel's first quarter guidance has recently revealed that the steelmaker's earnings will return to negative territory. The company expects to report a net loss of $0.44 to $0.49 per diluted share of common stock. Should investors worry about this?

One-time negative factors affect earnings
AK Steel mentioned two main factors that will cause a first quarter loss. The first one is the severe weather, which led to high energy costs. Nucor (NUE 0.30%) also blamed weather conditions for a decrease of its first quarter guidance. Nucor now expects that its first quarter earnings will be in a range of $0.30 to $0.35 per diluted share, down from fourth quarter earnings of $0.53 per share.

In addition to the impact from weather conditions, AK Steel's results suffered from an unplanned outage of its Ashland Works blast furnace. As a result, the company expects a 10% to 12% decrease from its fourth quarter steel shipments. The key thing to think about is that both weather conditions and the shipments decline are one-time events that would not affect future results.

On the positive side, the average selling price for the first quarter of 2014 will increase by approximately 6% thanks to a richer shipment mix of value-added products. The higher share of value-added products is an important long-term factor. As pricing for base products remains soft, the increase of value-added products share in the revenue mix improves the profitability of the company.

Long-term outlook stabilizes
Although steel producers face increasing competition from aluminum producers like Alcoa (AA) on the automotive market, it's too early in the game to draw final conclusions about the future share of aluminum in the auto production. Just like many steel producers, Alcoa tries to grow the share of its value-add products in the revenue mix as the aluminum prices are depressed, and aggressively markets its solutions to the auto industry. While the possible threat from aluminum producers is yet to translate into real numbers, AK Steel's exposure to growing domestic auto production strengthens its position.

While AK Steel's first quarter numbers will be bleak, the company is expected to return to profitability in the second quarter. The company is currently valued at less than 8 times its future earnings, way below U.S. Steel's (X -0.79%) 12 forward P/E and Nucor's 14 forward P/E. As AK Steel returns to positive operational cash flow, its market valuation will rise closer to its peers.

AK Steel's significant $1.5 billion long-term debt might worry some investors, but the company has no significant maturities coming until 2018, when it will have to repay $380 million. Before this, AK Steel has plenty of time to improve the profitability of its business and grow its operational cash flows.

Bottom line
The future looks promising for AK Steel. The company's business is on the right track despite the problems in the first quarter. The increase of value-added products share in the revenue mix is an encouraging sign. While the balance sheet could have been better, AK Steel doesn't have significant debt maturities until four years from now. The company trades at a discount to its peers, and this discount is likely to decrease in the future as AK Steel's operations gain steam.

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Nucor. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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