AK Steel Holding Corporation (NYSE:AKS) is struggling again. AKS stock has fallen 19% in the last two sessions despite what looked like decent fourth quarter earnings on Tuesday morning.
But there are reasons in the report and the Q4 conference call for the selloff. The company’s recent acquisition of Precision Partners is off to a slow start. Analysts clearly are concerned about pricing and input costs — margins should be a lot better in 2018 than directional guidance from the call suggests.
What’s clear coming out of Q4 is that investors just don’t trust AK Steel, and with good reason. AK Steel stock has underperformed the industry for years now. Execution is choppy at best. And while AKS has rallied from what appears to be an all-time low reached nearly two years ago, it should be doing well in a reasonably strong macro economy.
In fact, it should be doing much, much better. The fact that it’s not raises questions about what happens when the economy stops cooperating, or why investors should own AKS stock instead of other steel stocks if the economy continues to strengthen.
AK Steel Stock Has Gained But Not Enough
Looking at a group of six major steel stocks over the past year, AKS stock far and away has been the worst performer.
ArcelorMittal SA (ADR) (NYSE:MT) has led the pack, gaining 53.4%. Steel Dynamics, Inc. (NASDAQ:STLD) and United States Steel Corporation (NYSE:X) have gained 31% and 13%, respectively. Worthington Industries, Inc. (NYSE:WOR) has fallen 2.3%; Insteel Industries Inc (NASDAQ:IIIN) has dropped 14%.
AKS stock, meanwhile, has fallen 37%. Even before the declines this week, it was lagging the sector, and relatively badly. And this isn’t a new problem. Over three-year and 10-year periods, AKS is the worst performer among these steel stocks. (It does narrowly beat MT over the past five years; AKS stock has gained 29% over that stretch.)
Past performance doesn’t guarantee future success (or failure), of course. But at the least, it’s clear that AK Steel simply hasn’t measured up to the sector. And the more recent declines are all the more disconcerting given that AKS is the most leveraged play of the six. Steel prices have improved; overall, the sector has rallied over the past few years.
In that scenario, the company with the most leverage should in theory gain the most. That’s the reward taken for the risk of that debt. Yet AKS stock has been the worst. That’s a big concern because it raises several key concerns looking forward.
Why AKS Stock Fell After Earnings
The most obvious concern is the fact that AK Steel simply doesn’t seem to be executing all that well. Q4 didn’t help confidence on that front.
One analyst said investors were “pretty perplexed” by the company’s commentary that price increases would be offset by rising costs in 2018. “The point is you’re kind of running to stand still,” Curt Woodworth told Bloomberg — an apt description for AK Steel as a whole since the recession.
The company’s acquisition of Precision Partners already is coming in below expectations, with the company pulling down expected 2018 EBITDA contribution.
CFO Jaime Vasquez attributed the reduction — $50 million down to $40-$45 million — to the ramp of new business and minor accounting changes. But acquisitions that stumble early tend to stumble often, and Precision Partners is targeting the same automotive market where U.S. unit sales appear to be declining.
Honestly, Q4 wasn’t that bad, either in terms of results or commentary. But combined with investors’ lack of trust in AK Steel overall, it was bad enough to undercut the bull case and send the stock tumbling.
Easier Money Elsewhere
And it’s tough to see the case to buy the dip here. AKS stock does look cheap, trading at less than 8x 2018 analyst consensus. But there are some caveats there.
First, the range of earnings estimates is extremely wide ($0.40-$0.84), and consensus may come down further after Q4 guidance. Secondly, there’s a ton of debt here: the net leverage ratio is over 4x.
AK Steel wants to pay that debt down, but without growth, that will be tough. The company generated $420 million in EBITDA in 2017, a figure that should rise to the $450-million range in 2018.
But $160 million of that will go to capital expenditures. Another ~$140 million will be spent on interest, even after a recent debt refinancing. $50 million more goes to the pension. Even assuming minimal cash taxes, AK Steel will have maybe $100 million in free cash flow against $2.1 billion in debt (and ~$900 million in pension liabilities).
So, yes, AK Steel stock is cheap, but the sector itself isn’t expensive. US Steel stock still looks like a buy, as Nicholas Chahine argued a few months back, and trades at just 12x forward EPS. MT and STLD are in the 11-12x range. If an investor wants to go long steel for either macro considerations or the hopes of a Section 232 ruling, there are simply much better, safer plays than AKS.
That’s been the case for most of the multiyear rally in steel stocks, and it’s likely to be the case going forward. AKS stock may still have a bounce or two left in it. But there’s a reason it’s selling off and plenty of reasons why investors should look elsewhere in the space.
As of this writing, Vince Martin has no positions in any securities mentioned.