Earlier this year, investors were worried that AK Steel (AKS) would feel a liquidity crunch due to its pension liabilities. The stock has been falling due to concerns over pensions, commodities prices, and an overall slowdown in the global economy. Year-to-date, the stock is down more than 55%.
This month, the company announced multiple securities offerings that helped it raise more than $500 million. The offerings included $350 million of 8.750% senior secured notes due 2018 and $150 million of 5.00% exchangeable senior notes due 2019, as well as 22 million shares of AK Steel common stock with a value of $88 million.
This offering has allowed AK Steel to more than double their current liquidity position. Before the offering, the company was primarily using working capital as a form of liquidity. Now with the additional capital, the company will have more breathing room.
The WACC for all three offerings is 6.48%. I did not add in a cost of capital for the common stock because the stock is not paying any dividends and it's extremely difficult to gauge what return investors are expecting.
Now let's take a look at one their biggest liabilities, which are the pension liabilities. The company has funded its pension liabilities for this year, so we need to take a look at the next two years. This year, the company is paying a $170 million for pensions. Next year, the number is expected to be $180 million. In 2014, the number is expected to be $240 million.
Based on the growth of liabilities, it makes sense why investors would be concerned. In the next two years, the company is expected to pay $420 million in liabilities.
So is there a bright side to this story?
Well the pension funding is expected to peak in 2014 and then fall substantially. This is because the company is no longer taking in new entrants into the program. So as pension members begin to die due to mortality, the amount need for funding each year will decline.
Not only will mortality bring liabilities down, but so will an increase in interest rates. The company has estimated that for each 25 bps increase in interest rates, their pension liabilities will decrease by $75 million. Pension funds usually face problems when rates are low. When this happens, the amount of funding required needs to be increased, thus creating a larger deficit. While I do not expect rates to rise soon, they will rise eventually and this will mean AK Steel won't have to worry as much about its pension obligations.
AK Steel has done a fantastic job of reducing other employee liabilities. The company used to have total OPEB liabilities of $2 billion. Management has been able to reduce the amount to $1 billion.
Though the money raised from the offering is actually going to be used to pay down their line of credit instead of its pension liabilities, the extra capital will strengthen the company's financial position. The extra capital is costing the company 6.48% to borrow and AK Steel might be choosing to borrow now in case of a worsening steel industry. If the steel prices continue to fall, AK Steel would be in trouble as credit markets would be tighter for the industry as well. So AK Steel's choice to borrow now is a wise one as it allows them to lock in a significant amount of capital without taking the risk of waiting.
With a fully paid off revolver, the company still has a credit facility of more than $1.1 billion, which they can tap any time they want. This revolver should help smooth out issues related to working capital needs.
AK Steel no longer has a problem with liquidity. Going forward, pension liabilities will peak in 2014 and begin to fall. If interest rates begin to rise in a couple years, this will also decrease pension liabilities at a faster pace. I believe liquidity concerns for the company are overblown.