After the deep 2007 to 2009 recession, the cyclical U.S. steel industry entered a long downturn. Making matters worse was an influx of cheap foreign imports into the United States. Every major domestic steel stock felt the pain. Now, however, with the steel industry benefiting from an industry upturn, financially strong steelmakers like Steel Dynamics, Inc. and Nucor Corporation are posting solid results and stock gains. AK Steel Holding Corporation (NYSE: AKS), however, has lagged far behind. Is AK Steel a contrarian opportunity or a risk not worth taking?
Trailing the pack
Over the past year, the stock prices of Steel Dynamics, Nucor, and ArcelorMittal are higher. Even United States Steel, one of the weaker companies in the industry, has seen a notable stock price advance. None of this is surprising given that steelmakers have been benefiting from relatively strong demand and generally higher prices. It's been a good time to be a steel company.
AK Steel, however, has seen its stock fall a little more than 20% over the past year. It's the only major steel stock that's lost value over that span. Its GAAP earnings went from a three-cent loss per share in 2016 to a profit of two cents last year, so at first blush, its business appeared to be on the mend. However, adjusted earnings fell 45% in 2017. Worse, first-quarter earnings at this steelmaker declined 65% year over year. While the company benefited from higher prices and improving demand in the quarter, an unplanned outage at the Middletown Mill caused the leak in its financial results.
A mill outage is usually a short-term issue, which might lead some investors to believe this is an opportunity to buy a steelmaker while investors are feeling overly negative on the stock for temporary reasons. Only AK Steel's problems are bigger than just one mill.
Still dealing with the hangover
When the steel downturn hit following the recession, AK Steel ended up taking large write-offs. That pushed the company's shareholder equity into negative territory. Shareholder equity went negative in 2012 and has remained in the red all the way through to the first quarter of 2018. To be fair, AK Steel has improved this metric over the last couple of years, but it hasn't dug itself out of the hole yet.
Although it's nice to see the company repairing this aspect of its balance sheet, negative shareholder equity means that debt makes up more than 100% of the capital structure. That's not a sign of strength. However, shareholder equity is just one part the capital structure equation -- debt remains a troubling issue all on its own. Long-term debt spiked during the long steel industry downturn. After an acquisition in 2017, AK Steel's long-term debt now stands at roughly $2.1 billion. That's over three times the long-term debt the company was carrying in 2011.
With weak financial performance, covering that debt load hasn't been easy. For example, the company's debt-to-EBITDA ratio is a high 4.6 times. Compare that to Steel Dynamics' 1.6 times debt-to-EBITDA figure and you get a feel for just how leveraged AK Steel is today. Interest expense, meanwhile, ate up 60% of its operating profit in the first quarter. Although the mill closure noted above was a contributor to the weak quarterly results, adding a high level of debt to the equation clearly made matters much worse for AK Steel.
A long way to go
To be fair, AK Steel has been working to get its house in order. It's been rationalizing its product portfolio and working to extend debt maturities and lower interest costs. It has made progress on both fronts. And while debt jumped in 2017 because of a strategic acquisition, its long-term debt is lower today than it was three years ago. That said, the lingering weakness on the company's balance sheet remains a notable headwind that isn't likely to go away anytime soon.
Like other steelmakers, the industry upturn should help AK Steel improve its fortunes...but it still has a long way to go before its turnaround is complete. And that's the real problem. AK Steel is struggling to get itself back on track in a relatively good market. However, the steel industry tends to be highly cyclical. If steelmakers are faced with another downturn before AK Steel can right the ship, the company, and its shareholders, could be in for a lot of pain. For most investors, AK Steel's stock doesn't seem worth the risk.
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