AK Steel Is Well Positioned Despite Dramatic First Quarter

AK Steel's production and cost performance will improve as the company recovers from the difficult first quarter.

Vladimir Zernov
Vladimir Zernov
Apr 23, 2014 at 3:18PM
Energy, Materials, and Utilities

When a company's CEO starts the quarterly earnings call with the words, "Thank goodness it’s behind us" one would expect catastrophic results from this company. Interestingly, this was not the case for AK Steel (NYSE:AKS), whose CEO James Wainscott said that the first quarter was more than challenging. AK Steel finished the first quarter with an adjusted net loss of $54.4 million, worse than analysts' expectations. However, as the first quarter is now in the rearview mirror, investors can focus on the future performance of the company.

First quarter results are bad due to one-time events
AK Steel's first quarter results were pressured by several one-time events. First, the harsh winter weather pushed electricity and gas prices higher, while keeping the railroads behind schedule. In addition to this, the company had an unplanned outage at its Ashland Works blast furnace. AK Steel also decided to perform planned work at the same furnace, which was previously scheduled to take place in the second quarter.

During the earnings call, the company estimated that the outages decreased its production by 100,000-150,000 tons. In fact, the company's shipments in the first quarter decreased by 158,000 tons compared to the fourth quarter. Importantly, AK Steel doesn't have any planned outages for the remainder of the year, which means that it will return to its normal production levels as soon as in the second quarter.

Expect lower costs going further
AK Steel's report revealed that pricing finally improved. Higher spot market prices and a more favorable product mix resulted in an average selling price of $1,096 per ton, up 6% from the fourth quarter of 2013. Just like other steel producers, AK Steel tries to increase the share of its more expensive products in the sales mix.

More than 50% of AK Steel's sales were made to the automotive market, which is currently in good shape. This market will likely drive up the share of value-added production, as AK Steel begins to compete with aluminum producers like Alcoa (NYSE:AA), which are hungry to take their piece of the automotive pie. While Alcoa is extremely optimistic about the future share of aluminum in car manufacturing, I remain skeptical. AK Steel believes that steel remains a cheaper alternative, and I share the company's views.

The fact that both iron ore and met coal prices are depressed is bad for miners like Cliffs Natural Resources (NYSE:CLF), which produces both materials, but good for steelmaking companies. The second quarter report will show improved cost performance, as the effect of harsh winter weather will be removed. What's more, AK Steel will finish construction at its Magnetation plant in the late third to early fourth quarter. Magnetation is expected to provide about half of AK Steel's annual iron ore requirements, protecting the company from possible spikes in iron ore prices.

Bottom line
The future looks promising for AK Steel as the company recovers from the tough first quarter. Automotive market, which is the main market for the company, is doing well. The costs will decline thanks to warmer weather and continued softness in iron ore and met coal prices. In my view, the company, which trades at less than 8 times its future earnings, has upside potential.