AK Steel Holding Corp (NYSE:AKS)
Q4 2015 Results Earnings Conference Call
January 26, 2016, 11:00 AM ET
Roger Newport - CEO
Kirk Reich - President and COO
Jaime Vasquez - VP, Finance and CFO
Douglas Mitterholzer - General Manager, IR and Assistant Treasurer
Evan Kurtz - Morgan Stanley
Justine Fisher - Goldman Sachs
Matthew Korn - Barclays
Timna Tanners - Bank of America
Aldo Mazzaferro - Macquarie
Phil Gibbs - KeyBanc Capital Markets
David Gagliano - BMO
Melissa Tan - R. W. Pressprich
Good morning, ladies and gentlemen, and welcome to AK Steel's Fourth Quarter and Full Year 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded.
With us today are Mr. Roger K. Newport, Chief Executive Officer, Mr. Kirk W. Reich, President and Chief Operating Officer, Mr. Jaime Vasquez, Vice President, Finance and Chief Financial Officer, and Mr. Douglas O. Mitterholzer, General Manager, Investor Relations and Assistant Treasurer.
At this time, I will turn the conference over to Doug Mitterholzer. Please go ahead, sir.
Thank you, Candice, and good morning, everyone. Welcome to AK Steel's fourth quarter 2015 earnings conference call. In a moment, Roger Newport will offer his comments on our business. Following Roger's remarks, Jaime Vasquez, will review our fourth quarter 2015 financial results, and together we will field your questions.
Our comments today will include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Included among those forward-looking statements will be any comments concerning our expectations as to future shipments, product mix, prices, costs, operating profit, EBITDA or liquidity. Please note that our actual results may differ materially from what is contained in the forward-looking statements provided during this call. Information concerning factors that could cause such material differences in results is contained in our earnings release issued earlier today.
Except as required by law, the company disclaims any obligation to update any forward-looking statements to reflect future developments or events. To the extent that we refer to material information that includes non-GAAP financial measures, the reconciliation information required by Reg G is available on the company's website at aksteel.com.
With that, here's Roger for his comments. Roger?
Thank you, Doug. Good morning. I appreciate you joining us on today's call. I'm excited and honored to be leading AK Steel. I am also pleased to have Kirk Reich, as our President and Chief Operating Officer leading both the sales and operations areas of our business.
Both Kirk and I recognize - along with the entire management team recognize the challenges that our company and the steel industry face and we are focused on taking these challenges head-on. As part of our strategy to better serve our customers and to improve our profitability, we have recently realigned our organization.
Kirk is now responsible for our sales, operations, quality and research and innovation teams. This will provide the optimal structure to ensure that we remain aligned throughout the organization in our request to provide unparallel value to our customers.
In addition, this change positions us well to provide our customers with unmatched multi materials steel solutions. As the only domestic producer of carbon, stainless and electrical steel products, AK steel is uniquely positioned to serve all of the critical steel needs of the world’s most discerning customers.
Moving on to our results, earlier today we reported our best quarter of 2015 and our highest adjusted quarterly EBITDA level since the third quarter of 2008, as we generated adjusted EBITDA of $168 million or $101 per ton for the fourth quarter of 2015.
And excluding the special charges, our team was able to deliver adjusted net income for the fourth quarter of approximately $54 million which equates to earnings of $0.30 per share. This was only possible as a result of the actions and a focus of our employees to lower our cost, improve our productivity and further enrich our mix towards greater levels of value added products.
So, let me take this opportunity to thank each and every one of our employees for their outstanding efforts particularly in the phase of very adverse market conditions.
It is quite apparent that the steel industry continues to face significant challenges as we enter 2016. These challenges include continued pressures in the global steel industry as the result of the massive oversupply steel primarily from China, that direct and indirectly impact others oversupply in all regions of the world and otherwise AK Steel is not a major player in the oil country tubular goods business, the significant downturn in that market is contributing to the excess capacity in those markets in which we do compete and to the overall steel market.
As we have been stating for several quarters now, the steel market in the United States has been flooded with what we believe are unfairly traded imports. While the import levels have indeed began to decline for many of those countries where preliminary duties are being levied, we still face significant ongoing import pressures.
To combat these challenges, all of our efforts are being focused in the area of margin enhancement. This starts with the topline sales, what we sell, and to who we sell it too. It also includes lowering costs, both the cost to produce our products, as well as our overhead cost.
Throughout all of this, we are sharpening the focus on our core business and those products and markets that provide a reasonable return to our company.
In 2015, we made some difficult decisions to better position our business for the long term success. Over the course of the year, we wrote off our investment in Magnetation in the first quarter as the result of the substantial decline in the iron ore market.
We revaluated our investment in a discontinued insurance operation. We took a cash distribution of $14 million from this entity and are nearing completion of its sale. And we idled the hot end of the Ashland Works facility in the fourth quarter.
These were not easy decisions, especially the temporary idling of our Ashland Works hot end, as we now have nearly 600 of our hardworking employees right off at this time. We are still operating a hot dip galvanizing line of Ashland Works that primarily serves the automotive market.
These were indeed the necessary actions to take and we continue to make improvements in all areas of our business.
From a safety standpoint, we continue to leave the industry by a wide margin. Both Dearborn Works and Mountain State Carbon improved their safety performance dramatically in 2015. A number of our other plan set new safety records during the year while others are continuing on record-breaking periods without a recordable injury.
Our operations continue to perform well as our employees find new ways to lower costs. It is their daily commitment to continuously improve which differentiates us from our competition. In other words, reducing cost is really just a normal way of life in our plans.
I am very pleased with the progress of integrating Dearborn Works, including in the areas of safety, environmental, quality and productivity. In 2015, we achieved about $59 million of cost-based synergies from the Dearborn acquisition. This is more than double our original estimate of $25 million in year one and above a year two estimate of $50 million.
With the recent idling of the Ashland hot end, we will be putting both the Dearborn and Middletown Works to the test in 2016 and I am confident that the entire AK Steel Workforce will deliver.
Our overall market conditions remain challenging. We remain steadfast in our focus on generating respectable returns on our business, both from a selling price and from a cost perspective. Towards that end, we recently announced two carbon steel price increases and one stainless steel price increase and spot market prices have indeed begun to rise over the past several weeks.
On the contract side of our business, demand in our core market automotive remains very strong. In 2015, light vehicle sales in the United States totaled approximately 17.5 million vehicles marking the sixth straight year of growth ended all time high for light-vehicle sales.
Strong auto sales also leads to strong auto production. We focus more on light vehicle production than on the sales rates as many vehicles manufactured in the NAFTA region are then exported.
For 2015, North American light vehicle production also totaled approximately 17.5 million vehicles, again a record year. And vehicle inventories remained stable at 61 days of supply at the end of 2015.
In the fourth quarter, our automotive shipments represented about 58% of our total shipments. This is the evidence of the strategic actions that we have taken and continue to pursue in order to grow the more differentiated value added portions of our business by minimizing our exposure to the commodity products.
Quite simply, we remain focused on producing and delivering fields that are difficult to manufacture and thus command higher prices. We remain committed to the automotive market and we work closely with our customers to provide them cutting edge technology to assist in their ongoing efforts to reduce vehicle wait.
Examples of our innovations in this area include next generation advanced high strength steels for body and white automotive structures, as well as Thermax 17 for future designs in automotive exhaust systems.
Light automotive, electrical steel product is another core market for AK Steel. Demand for our premium quality high-efficiency electrical fields remain strong and we are responding in kind to meet the needs of our valued customers.
In the first quarter this year, we will be completing the final phase of a capital investment to expand our production capabilities for the high-value added grain-oriented electrical steels for both the U.S. and the global markets. The project includes the installation of new production equipment at the Company's Butler Works to upgrade an existing processing line at that facility.
As a result of this investment, the new equipment will increase our capacity about 5% for TRAN-COR DR and CARLITE families of high permeability steel grades.
In addition to enhancing production capacity for higher quality grades of electrical field, the project will also improve our product mix flexibility. This project is yet another step in helping our customers meet the increasing energy efficiency standards around the world.
On the stainless side of our business, AK Steel remains the market leader in the world of automotive exhaust system. 2015 was a record year for our shipments of auto chrome products and further growth in this niche, an highly demanding segment is expected in the coming year. Likewise, demand for other chrome grades such as those employed and exposed automotive trim applications remains robust.
Yet, not all segments of our stainless market are as attractive as those just described. One component of our strategy has been to limit our participation in the commodity chrome nickel market. This has proven to be a wise action, particularly given the significant decline in nickel prices that occurred in 2015.
Switching over to the carbon products, the significant decline in spot market prices over the past 18 months has been well publicized throughout the industry. Unfortunately, as we've indicated before, contract business is not immune to these pricing pressures.
At AK Steel, one of the reasons that we focus on the automotive contract business is that over time the pricing is not nearly as volatile as in the spot market.
So while directionally contract and spot prices tend to move in units and the pricing peaks and valleys experienced over the course of the cycle are significantly reduced on the contract side. And going into 2016, the historical relationship between spot and contract pricing continues.
Current contracts expired in the course of 2015 and our average selling prices were impacted by the effects of those explorations in the second half of the year. Other contracts we'll renew in the first half of 2016 and the impact of any changes relating to those renewals will be realized in 2016.
Other spot market prices appear to be rebounding in recent weeks that remain quite low by historical standards. The impact of unfair trade on the domestic steel industry is undeniable and we remain hopeful that our legislators in Washington will take appropriate actions to address this situation.
On the trade case front, the steel industry has made some progress in recent months, but not to the level we had anticipated. For example, in the corrosion-resistant trade case, the preliminary duties levied against China were quite in line with industry expectations. Yet the preliminary anti-dumping duties for other countries were rather disappointing.
At AK Steel, we will continue to explore all potential trade actions to help ensure that we return to a level playing field here in the United States. The impact of China's severe over capacity on all regions of the world raises additional challenges in the fight for fair trade, but rest assured, we will continue in our efforts to level the playing field on unfairly dump in subsidized imports.
Internally and externally, we stress the development of our strategy is not a one-time event but its limits to just a certain set of initiatives. Instead it is a collective set of actions to achieve the ultimate goal of improving our profitability and parts of our strategy must and will remain flexible.
Why, because things change. For example, just in the last 18 months import levels increased dramatically, market prices for many commodities fell precipitously, the energy market declined substantially, steel pricing came under severe pressure due to imports, the auto market experienced a record year and three flat rolled carbon steel trade cases were filed.
In the midst of this changing landscape, we're focused on controlling things within our control, improving our product and market mix to optimize our returns, investing in our higher end growth products, reviewing every asset, every product in every market and developing new and exciting products and processes.
In 2015, we continued great progress on research and innovation front and this will be a key focus area for us going forward. We introduced new products to the specialty tubing market as well as the automotive OEM market for lightweight. Additionally, we announced that in investment in our Dearborn Works galvanizing line to produce next generation coated and cold-rolled advanced high strength steel.
We expect to begin production of these products later this year and we also began construction of our new research and innovation center. We expanded our research and innovation team by nearly 30% compared to 2014, demonstrating our renewed and accelerated focus on new products and processes.
At AK Steel, we're instilling the culture of we can and we will. What I mean by this is that in every aspect of our business whether it is safety, quality, operations, customer support, sales, working capital, research and innovation in our any other area of our business, if we can control it, we must control it and we will control it.
In addition, Kirk and I are focused on capitalizing upon the collective knowledge, wisdom and experience of our employees to improve our company. To this end we just launched our great ideas program. We believe that our employees are an invaluable resource of finding ways to improve AK Steel. I know our team will continue to step up and I look forward to putting their ideas into actions.
Thus I want to leave you with these thoughts. AK Steel is unique because we're able to provide a multi-material solution for our customers, whether it is the various grades of carbon steels including next generation advanced high strength steel or stainless steels or electrical steels.
In addition, we are able to convert shipments carbon and stainless level products into tubular products at our AK tube operations. On the stainless front, we were able to expand our light gauge stainless product offerings to our combined metals - through combined metals our joint venture located in Chicago.
We will continue to develop innovative new products and processes to provide the best value to our customers. We will align all of our resources with the needs of our business to ensure that we are getting return on those resources that we are investing in the business.
We are investing our business where we identifying adequate return to our shareholders and bondholders, and we will control those items within our control because I know that the entire AK Steel can and will make AK Steel a stronger company.
Now before turning the call over to Jaime Vasquez, our Vice President of Finance and Chief Financial Officer, I want to welcome and congratulate Jaime and assuming his new role. Jamie is well suited to help us transform our business as we drive to position it for sustained profitability in the future. Jaime?
Thank you, Roger. As Roger indicated earlier, AK Steel reported adjusted net income of $53.8 million or $0.30 per diluted share for the fourth quarter of 2015. This compared to our earnings guidance of a net loss of $0.33 to $0.38 which included an estimate for charges of $0.42 per share related to the temporary idling of the Ashland Works blast furnace and steel making operations and the impairment of our discontinued insurance operations.
These adjusted results for the fourth quarter represented a substantial improvement compared to net income of $6.7 million or $0.04 per share for the third quarter of 2015 and adjusted net income of $26.1 million or $0.14 per diluted share in the fourth quarter a year ago.
The recent fourth quarter improvement reflected the benefit of lower raw material costs, strong automotive demand and our decision to reduce exposure to the carbon steel spot market as part of our margin enhancement strategy. Also included in the fourth quarter results is higher than expected LIFO credit which I’ll discuss further in a movement.
Looking at shipments, our mix of tons shipped improved in the recent fourth quarter as a result of strong automotive demand and our decision to reduce exposure to the carbon steel spot market. This resulted in fourth quarter shipments of approximately 1.66 million tons which were 215,000 tons or 12% lower compared to third quarter of 2015.
Sales for the fourth quarter were $1.54 billion which was $167 million lower than the third quarter. This decrease was driven by a reduction in shipments to the carbon steel spot market, as well as lower spot market pricing resulting from continued high levels of what we believe are on fairly traded imports. The sharp reduction in spot market pricing also resulted in sales that were 23% lower than the fourth quarter a year ago.
Our fourth quarter 2015 results included $7 million of cost associated with plant major maintenance outages. This compares to roughly $12 million in outage costs of third quarter of 2015.
Our adjusted EBITDA for the recent fourth quarter was $168.1 million for $101 per ton. As Roger mentioned this was our best quarterly performance in more than seven years. This also represented an improvement of $48 million or $37 per ton compared to the third quarter of 2015 and a $51 million improvement or $43 per ton from the fourth quarter a year ago.
The EBITDA increase in the recent fourth quarter compared to the third quarter of 2015 and the fourth quarter a year ago is due in part to the effect of lower raw material costs combined with strong demand from our automotive customers. Additionally, our relentless focus on costs and operational improvements help drive the increase.
In the fourth quarter of 2015, we recorded a LIFO credit of $98.6 million compared to a LIFO credit of $44.8 million for the prior quarter and $5.3 million in the fourth quarter a year ago. The fourth quarter LIFO credit was primarily driven by strong operating cost performance and higher shipments.
In the fourth quarter, we had three special charges that are excluded from our adjusted net income. These special charges totaled $200.9 million or $1.13 per diluted share and included a net quarter charge related to pension and post retirement benefits in the amount of $131.2 million or $0.74 per diluted share.
This consisted of a pension corridor charge of $144.3 million, partially offset by an OPEB corridor credit of $13.1 million. The net corridor charge was driven primarily by the weak performance of the financial markets partially offset by an increase in the discount rates of roughly 30 basis points at year end 2015 compared to year end 2014.
The second charge as we previously announced was related to our decision to temporarily idle the Ashland Works hot end operations in December. We recognize a charge of $28.1 million or $0.16 per diluted share with a supplemental unemployment and other employee benefit costs, as well as other expenses incurred to temporarily idle the operations.
The charge reflects the assumption that the temporary idling will likely last throughout 2016. However we will reassess market conditions regularly to determine when to restart the Ashland Works hot end operations.
The third charge is related to our investment in AFSG which is the holding company of AK Steel's discontinued insurance operations. As part of our strategic reviewed optimized assets, we made a decision to receive a cash distribution of $14 million from AFSG. In connection with this distribution the remaining investment in AFSG was determined to be impaired and we recognize a non-cash charge to write-off the remaining investment of $41.6 million or $0.23 per diluted share. AK Steel has no financial obligations to AFSG.
In the fourth quarter of 2014, adjusted net income excluded $7.1 million costs related to the acquisition of Dearborn Works, as well as a pension corridor and OPEB settlement charges of $5.5 million.
Highlighting our result for full year 2015, sales were approximately $6.7 billion, an increase of $187 million or 3% compared to 2014, primarily due to the full year inclusion in our results of Dearborn Works and increased automotive sales.
Shipments for 2015 were nearly 7.1 million tons, an increase of 957,000 tons or 16% compared to 2014. Once again, the increase is mostly due to the acquisition of Dearborn Works, as well as continued strength in the automotive market partially offset by reduced shipments to the carbon steel spot market.
Moving from sales to our operations, we incurred approximately $51 million in plant maintenance outage costs during 2015, roughly $24 million lower than the prior year. In 2015 we had no major on plant mill outages which is truly a credit to our operators at the plants.
In 2014 we incurred on plant outage cost of $41 million at our Ashland Works blast furnace. In addition, last year also included about $45 million in cost related to extreme winter weather conditions.
At the bottom line for 2015 we reported an adjusted net loss of $53.5 million or $0.30 per share. This compares to an adjusted net loss of $59.7 million or $0.40 per share for 2014. In addition to the recent fourth quarter special charges I mentioned, our adjusted results for 2015 excluded first quarter charge of $256.3 million or $1.44 per share to fully impair our investment in the Magnetation joint venture.
Our adjusted results for 2014 excluded expenses of $31.7 million or $0.21 per share related to the acquisition of Dearborn Works, as well as a corridor charge of $5.5 million or $0.04 per share.
Turning to the balance sheet and the cash flow statement, for the fourth quarter of 2015 our capital investments totaled $27.2 million bringing our capital investments for the year to $97.3 million. This reflects our strategy to focus our resources and capital in those areas where markets pay for the value that AK Steel delivers.
In the fourth quarter working capital was a use of cash $112.8 million. This was primarily the result of the plant increase and inventory levels as we transition production from Ashland Works to Middletown and Dearborn Works. To the full year 2015 working capital was essentially flat.
I would note that our credit facility borrowings remained the same from the end of the third quarter to the end of the fourth quarter of 2015. We actually lowered our borrowings under the credit facility by $55 million in 2015.
I’d also note that our total debt, pension and other post retirement employee benefits were OPEB liabilities decreased by $124 million in 2015 compared to the end of 2014. This is partly attributed to our focus to reduce liabilities.
Total liquidity at year end was a solid $700 million with no debt maturities until the end of 2018 and no required pension contributions in 2016. The $700 million of liquidity is more than sufficient to meet our needs in 2016. Although we’re very comfortable with our liquidity position, we will continue to further improve our working capital management, as well as focusing on other liquidity enhancing actions.
Now turning to our outlook, we would like to provide you with some data points for 2016. The current year we anticipate capital expenditures to be in the range of $120 to $140 million including approximately $40 million of related growth investments. These growth projects such as the coding line modifications at our Dearborn Works which will allow us to produce next generation advanced high strength steels are important pieces of our strategy to focus on higher value and innovative products.
We expect our plant maintenance outages in 2016 will be about the same as the $51 million we had in 2015, and we do not have any major blast furnace maintenance outages planned for the current year. We expect working capital to be a modest source of cash in 2016 as a result of reduced exposure to the commodities spot market.
With respect to LIFO, we currently do not expect a large LIFO credit in 2016 primarily as a result of more stable raw material prices. We anticipate that our pension and OPEB credit for 2016 will be approximately $50 million compared to a credit of $63 million for 2015.
Our 2016 depreciation expense including our variable interest entities is expected to total approximately $213 million compared to $216 million in 2015.
Finally in regard to income taxes, our 2016 book tax rate as in recent years will be primarily driven by a function of changes in our LIFO reserved. In addition, given our NOL tax carry-forward position, we expect that our cash taxes will continue to be very minimal.
And specifically for the first quarter, we see shipments declining marginally from the fourth quarter as continuing strengthening the automotive market is more than offset by an expected decline in shipments to the commodity spot market based on current market conditions.
Additionally, we estimate our average selling prices to be about the same as the recent fourth quarter. The additional insight we're providing reflects the change in our approach providing earnings guidance. We provide you with as much information as possible going into a quarter as opposed to providing earnings guidance near the end of the quarter.
Finally, I’d like to reiterate Roger's remarks. The AK Steel management team is very focused in terms of how we want to strategically position AK Steel. We've a great foundation to work from because we believe our quality, breadth of product, customer service and innovation is industry leading positioning AK Steel to deliver more value added products and services while minimizing underperforming assets and low margin products will take time. We will continue to discuss our progress and let me assure you this team is acting with a keen sense of urgency in returning the company to a sustainable profitability.
Let me conclude my comments by saying, thank you for your interest in AK Steel. And at this time, we'd be happy to take your questions.
[Operator Instructions] And our first question comes from Evan Kurtz of Morgan Stanley. Your line is now open.
Good morning, guys. I was surprised by your last comment there, if I heard that right, did you say that ASPs for the first quarter would be similar to the fourth quarter?
Yes. That will be similar as we get richer mix as we reduced sales to the urban spot market.
Yes, surprising because you have a lot of contracts you said in January, which I assume are coming down, what are some of the other moving pieces that are offsetting that?
Well part of this we’re going to be reducing what you are selling into the carbon spot market. So we will be lower on our hot rolled and cold rolled products. So that would be a decline and we are continuing to see strong demand in the automotive business.
So we continue to see strength in that market quarter-over-quarter. And in the fourth quarter you'll see a little bit of seasonality with the holidays and that demand for the automotive products.
So those are couple of factors. In addition, continued growth in our electrical steel products especially the higher end – high efficiency electrical steels that will continue to grow in that market too.
So it’s a market mix and a product mix and as we have been indicating it is getting away from the commodity side reducing our exposure there and being more focused on the value added products.
That's great. Thanks for the color on that. Other question I have is just on the cost savings great ideas program. Are you going to come up with some sort of a way to communicate that on a regular basis about quantifying goals and targets and updates quarterly or how is that going to work?
We need to show it at bottom line and that's our goal is to improve it. And we talked about cost reductions but we focus more internally on margin enhancements which includes cost reductions.
So example in 2015 some of the initiatives we have taken, we worked on reducing our slab cost by changing the burden of how we operate our furnaces to make sure both at the blast furnace side and at our melt shops to get the lowest cost of raw material blends to make our slabs.
We have been working on optimizing what we’re doing at our melt shops on how we are producing carbon slabs and where we are producing that. So we did that throughout 2015.
On the coal front, actually our AK coal operations has done a great job in working on becoming very competitive in their capabilities to produce cost. So those are few items that I would say was closer to $65 million of improvement that we had in 2015 compared to 2014.
In addition, we continue to focus on lowering our overhead cost and then on the durable and work side as Jamie had mentioned we had about $59 million in cost based synergies. So we have lot of activities there.
So going forward, we will continue to update everyone on how we’re progressing in reducing cost because ultimately that's what we need to do as a company as to figure out how to reduce cost. Also we have focused on in communicating what we’re doing to improve our product mix and our market mix and to be more focused on those more value added products.
Thanks for all the detail.
Thank you. And our next question comes from Justine Fisher of Goldman Sachs. Your line is now open.
Just a follow up on the last question regarding the pricing. So it sounds like you guys do expect contract pricing to decline based on your prepared remarks in your response to Evan's question that there are just going to be thing offsetting. And so when we really looking at the coated and the cold rolled pricing, I know you guys don’t disclose it most of us probably modeling some margin versus hot roll to that given what we heard most recently about the dispersion in prices between hot roll and coated and cold rolled but then also taking into account decline in contract prices.
How should we think about the way that price could move - I’m not asking for a number because I know you’re not going to give it to us but in percent basis or anything could help us understand how prices for those products might move given the puts and takes?
Sure. As we had mentioned if contract pricing moves, it will parallel to what is happening in the spot market but it is just not to the order of magnitude that you see in the spot market. That has been history and continues that way. And the good thing is it just doesn’t have the volatility and as we look at our products, we look at making sure we provide quality service delivery and in those new products, in that research and innovation for our customers because that is the thing we are looking for in the future and make sure we are good supplier to our customers.
So if you look at it on the pricing front, it is definitely not the level of what you see declines in the spot market that you would see in the contract side and partially offset that would be some benefits you get on the raw material front. We’ve seen iron ore drop as you know we buy our iron ore based on the IODEX, a component of the pricing for the iron ore is based on the IODEX, so that has continued to decline throughout 2015 and still continues to decline here in the first half of 2016 and the forward curve shows that it’s going to continue to stay pretty weak.
And that's actually a advantage we have at AK Steel compared to others. Scrap is falling at normally were parallel what’s happening in stock market pricing. In addition we’ve seen coal prices drop and everyone's a while where what’s been happening in the energy markets as we can see a lot of natural gas so that will be helping us.
So, I’m not saying that the cost reductions on the auto front will offset the pricing it will not but we do have some opportunities to help overcome some of the price decreases that we have seen in the automotive industry.
And in terms of overall materials, obviously I know you guys pricing these on the lag, especially iron ore and so even if we would assume iron ore prices are flat, you may get some release on the raw material front in the first quarter. Can we expect that to continue in 2Q, 3Q if the spot market prices are flat or should if everyone kind of flat lightening these commodity prices, that really low levels is this going to be, is kind of the end of the raw material release that we’ve seen in '16 it will just kind of stabilize and stay low but there is not much more room for leg down after 1Q.
I think if you look at the commodity prices of what we’re seeing in the 2016, we’ve seen scrap actually start to move up little bit and I think that will parallel what happens with the overall pricing and the spot market pricing.
On the coal side our contracts are annual contracts calendar year contracts so we have our pricing completed for 2016 when it comes to the coal side which is really the main ingredient for making coke.
And we do had some of our raw material or energy cost, so some of that we have locked in also. So, I would say we don’t see as much volatility but I’ll never say never because I was shocked what happened here in 2015 with some of the declines that happened in the energy markets and the raw material markets but it seems like they have gotten the pretty low loads.
Okay, thanks. And then the last question I have is just on CapEx. Most of the companies that we look out on the credit side whose bonds are trading in the range - your bonds are trading out of CapEx to kind of their bonds level and you guys mentioned in your previous remarks that you are going to focusing on the coding line - spending on some growth next year. Is that because you feel though you need to kind of defend that share from maybe other steel companies who are encroaching on it, what’s the reason for spending on growth CapEx when mainly the results have been very good but the environments not completely stable, let's say in terms of that the outlook for steel pricing et cetera.
Let's say if you look at the success of AK Steel and its predecessor company Armco, the thing we have been focused on is that new product coming up with new processes, new products for our customers and my belief is if you’re standing still, you're moving backwards because your competition is moving ahead of you.
So we're always going to be focused on, no matter what the market conditions are. I have been in the business for over 30 years is the cyclical business we understand it. You have to be smart about how you invest that capital when you put it and we believe we’re very prudent with our capital and how we put it into certain products example investing $29 million at Dearborn to get advance high strength steels and some of the other projects that I have mentioned - some growth in our high efficiency electrical steels and some other projects we have going on.
And our focus is for investing the capital we’re getting return on it. So that’s where we’re focused. We still have to maintain our equipment and we'll look at while we need to maintain and how we need to maintain it, and that’s always the - the challenge to keep those cost down as well as possible.
And I did want to also Justine go back on one other comment you were asking about pricing in the future. If you look at it from an integrated side and AK Steel side, is pricing which start to rise if the spot market prices rise. Actually that helps us because we’re only about fourth or so of our melt scrap related.
So actually as you see steel prices go up, normally scrap and carbon steel price, spot market prices parallel each other, so we actually get some margin expansion in the spot market as scrap prices rise compared to what happens with those that have many mills.
So I'd note that also that we been hurt as it has come down because we're not 100% scrap base, we've had some benefits from iron ore and other raw materials but not to the benefit that others have seen that were 100% scrap based.
Thank you. And our next question comes from Matthew Korn of Barclays. Your line is now open.
First question for you, you seem somewhat less fixated on imports perhaps is a remaining pressure in the market and maybe we have heard from some of your peers, Roger clearly not satisfied with what we have seen from the [indiscernible] decision so far. So first, is there a right number for you in terms of monthly imports relative to 115 million, 120 million ton U.S. consumption market?
And then second is there a next step that you can see us as far as pursuing additional policy measures. Is there room for some of these lower duty applications found for the non-Chinese imports to see increases in the final decisions? Do you bring about new cases? What more can you do?
Sure. If you look at the imports looking back overtime, normally imports have been about the low 20% of our market. I look back, back even early just even a few years ago was down about 20% or 22%. Currently it's been running around 29%. We beat that I think quarter last year around 34%.
So, imports have definitely been an issue. We have taken on several things, actions to address it. One is to trade cases. We have three trade cases that have been filed. We have countervailing duties have been assumed on all three of those cases and we're still waiting for anti-dumping duties to be accessed in hot-rolled and cold-rolled cases, which we expect to happen here in February and March.
We believe it's been very effective for China. As you've seen that if you put the two duties together, countervailing duties and anti-dumping, those are now totaling over 400%. But they have not been effective for some of the other countries being more in the single digit to low double digit percentages.
The challenge we're having and we're focused on is what I'll call the [indiscernible], which is monitoring where the import is coming from and make sure we're seeking all available remedies out there to ensure that we have a level plain field. Because the issue is, it's not so much imports coming in. They have and always will be part of our market. It's really what is the pricing of that material, and are they being subsidized or they're selling it at unfair levels?
We'll also look at any other options that remain out there on the table and addressing imports as they come in, because we can't sit still and let imports destroy the steel industry and other related industries. If you think about the impacts that its having on the steel industry, it also goes out to the mining industry, transportation industry, a lot of other industries they could impact it, not just our business alone.
So it's very important for us and we have a lot of people in Washington help us - helping us to fight - unfair trade and address the situations.
On that context, let me follow up and ask, do you expect looking at overall for 2016. Is there good shares, that will see U.S. total steel consumption growth to be up meaningful year-over-year or do you really see the main opportunity for domestic like yourself to replace tons and maybe last year were fulfilled by the imports. Immediately can I get your sense for any expectations of the growth rates over '16 for the main end markets and talking to investors now there are some concern, can we get high on the automotive relative to what we saw this past year for example?
When we look at the automotive industry, we are seeing that that is remaining very strong going up a little bit in 2016, but looks like most of the auto manufacturers are running pretty much near their capacity. So I don't know if there is really lot of upside for them to produce a lot more, but everything we're seeing is showing strong demand in 2016.
And that benefits us both on the carbon front and on the stainless front whether it's the chrome business or the chrome nickel business, because we have some high-end chrome nickel business also that goes into that market.
We're also seeing still solid demand when it comes to the construction, healing and air-conditioning markets. We are not a huge player in those markets, but that's still is an outlet for the fields to go into.
In regard to imports, we have seen the imports come down especially from the main countries that we have filed cases against. And we've been seeing the permit applications for imports, slowly declining also. So I think there is a lot happening out there.
In regards to at AK as you're well aware, we did idle our blast furnace of Ashland. We have three blast furnaces in our company and we did idle Ashland in December. So we have reduced our capacity and made no sense to be selling our products at the prices that were out there in the marketplace and not giving a return on our products.
Thank you. And our next question comes from Timna Tanners of Bank of America. Your line is now open.
A fire alarm just started to go off. I know it's a test, but I'm just warning you if you hear funny noise in background, I'm sorry for that. I wanted to drill down a little bit more into the grain-oriented electrical steel business. Our [indiscernible] some of the price gains in the bottom market that we saw this time last year have evaporated and over supply has been accentuated by weak global market.
However, I know that you have a different mix and a richer mix than your - the only other producer who recently decided to shut down. So I was hoping if you can expand a little bit more on, despite the versions and the high-end versus the more commodity and grain-oriented electrical steel? A, can you still get price increases year-over-year, if you can give us some color on that volume increases or decreases do you have any guidance there? And then do you think you can take any market share domestically or do you think that any additional volume would need to go overseas? Thanks.
I'll take that one. Efficiency standards are certainly helping and that is driving the demand for our high value added product or higher-efficiency product. And we are seeing growth in both those markets and our regular growth grain oriented market as well.
So both from a volume – certainly from a volume standpoint they are increasing. We're certainly seeing some market pressures from a price standpoint, but they're holding up very nicely. So that hasn't been an issue and really we're performing very well and increasing our capacity throughout 2016 compared to 2015.
Okay. As the years go on, it seems like there is a little bit more of a switch to amorphous and the Chinese excess supply situation doesn't seem to be abiding. What is your longer term or more medium term prospects do you think for that industry globally?
We think with the efficiency standard increases that we've seen, we see even more demand for our product. So we're very content that we're in very good spot there. We continue to work from a research and innovation standpoint, expected to within this year we're probably going to bring another advancement in our regular grain oriented. That's going to take another step function improvement and efficiency.
And we're going to remain the industry leader and producing the most efficient steels that are out there. And that demands some value and there are certainly a lot of our folks interested in that. So we're not concerned with that at all.
Okay. That’s really helpful. Thanks for the color.
Thank you. And our next question comes from Aldo Mazzaferro of Macquarie. Your line is now open.
On the question going forward, the promise you made about your pricing being flat on slightly lower volume and the fact that you may get raw materials declining in cost from the IODEX and other things. You just did $101 of EBITDA per ton. I'm wondering is there any reason to believe the number in the next quarter so would be much different?
Well, the comment I would make there, although is one of the items we have with a large LIFO credit in the quarter. So that did have an impact and as Jamie mentioned, we do not expect to have a large LIFO credit as we move forward here in the 2016 that will be primarily driven on what happens with raw material cost actually the driver for LIFO, but we did have a large LIFO of credit.
In regards to – as I mentioned on contract pricing, we do anticipate for the contracts we're negotiating here for the [indiscernible] effective to first of the year that the auto contracts do have lower pricing and that will be partially offset by some lower raw material cost and energy cost but we will see some pressure on our margin when it comes to the automotive side just reflecting the trends that we've seen in the spot market.
Roger in terms of that average selling price forecast of being about the same, are you assuming spot prices on average are lower in first quarter versus fourth?
I wouldn't comment yet on what we're seeing exactly going to happen in the spot market, but that it probably seen the slight uptick here with our two price increase announcements that we made and scrap has moved a little bit here, so we'll see what happens over the next two months and what happens in the spot market.
But we're not going to be a major player at spot market and that's why Jamie commented on every selling price, because we're going to be taking out the D&C spot tons a lot of the hot-rolled and cold-rolled tons.
So if we adjust on that, that would result in a higher average selling price. But with the pressures that we're getting from the contract pricing, that will put some downward pressure on it. And net of all together it's coming up to roughly a flat average selling price.
You got time for one more question?
In terms of the big picture, you've got a new leadership team here now in terms of your major strategic decisions, I'm wondering about you're thinking – you already go forward with the R&D and I'm wondering if you prefer in terms of your raw material mix to remain kind of a spot binder as majority or do you think you might want to move towards more of a flat or an integrated approach and also in terms of the pension funding like how quickly you think you want to just get that done or are you going to just do the minimums and devote some of your free cash flows to possibly doing things like reducing debt with your bonds trading as low as they are.
I'm just wondering about that use of the $700 million of liquidity you have. We don't think you have many requirements for it going forward whether there might be something in terms of the balance sheet improvement. Thanks.
I will take the second one first in regards to pension funding as Jamie mentioned we do not have any required pension funding in 2016 and really what drive in the future is what happens with our assets return that will drive our required funding. We have always taken approach just to do the minimum funding on that in regards to pension funding.
In regards to vertical integration we’re very happy right now with our position. We are out on a raw materials, we have a little bit of our coal that we get from AK Coal, the rest we buy in the marketplace as we’re fine with that and our vertical integration we have most of our iron ore we get from those natural resources and also get some magnetization agreement with magnetization.
So, we’re pleased right now as it does watch away all of the contract have some type of IODEX component in it, another drivers in it or pricing. So we like to float with the markets on that helps to align with what happens in the market prices.
So, our focus is as where we can invest the money to get our return as we talked about on their capital investments and on the raw material front, we see whether its iron ore or coal or other commodities if there is plenty of capacity and plenty supply out there and we don’t see any major changes in the near term for those markets raising.
Thank you. And our next question comes from Phil Gibbs of KeyBanc Capital Markets. Your line is now open.
I had just a follow up on Timna's question on grain-oriented in terms of the actual name plate capacity of the mix that you are trying to attain and where you are relative to that and then may be some color as to how you expect our shipments to develop this year?
That's a difficult question only be as it’s a very mix dependent. We have as Roger mentioned earlier we’re making a small investment that allows us to get more of the PCA to higher efficiency product and we’re doing that intentionally because that’s an improved better margin product for us.
However as we received more business in a regular grain oriented, we are continuing to fill our units and get more tons out. So, it's really difficult to pin down an exact because RGO [ph] versus TCH or national versus International really changes that very fluidly and we’re just kind of adjust with that and it's hard to pinpoint in a specific number for you. But we’re filling overall capacity, we’re getting nearly full and that’s a great thing for us.
Any thoughts on what we may or should expect for volume growth and the grain oriented business this year or just give us any feel for what that business did from a volume perspective in '15 maybe relative to '14. And then remind us how much your business now is called annual contract in terms of pricing.
The majority of it is annual contract pricing type of negotiations. We have increased a fair amount of more than 10%, probably pushing 20% year-over-year is what we would anticipate.
Thank you. And our next question comes from David Gagliano of BMO. Your line is now open.
Thanks. I wanted to come back to LIFO question on a couple of different sites. First of all, just I understand the comment regarding the benefit having or the impact being a big benefit this quarter but it is still confusing to me how much of that would actually translate into sustaining lower cost moving forward.
So all else held constant, $168 million of EBITDA, $101 per ton operating income what would that be without the LIFO credit. I know I can just do the math but how much of that LIFO credit translates to lower cost beginning in Q1 if that makes any sense.
David this is Jamie. Look, let me answer the second part of that. I think I would torn down any expectations for the large LIFO credit as we get into 2016 just based on an expectation that raw material prices, why they can get lower there is pie closer to a bottom.
And in terms of looking back at 2015, in total the LIFO for the year was almost $200 million. If you just hold everything flat going forward from 2016, you would say while that should be about $15 million per quarter.
So theoretically, you can say costs were maybe overstated than the first part of the year and then we caught up in the second part of the year and it has to do with the LIFO calculations. But I would just look at going forward and again like we said in our prepared remarks, the expectation for 2016 is a much smaller credit.
If you look at it from the LIFO side, raw materials continue to fall throughout the year. If you look at where we started at beginning of the year was the IODEX was at, where scrap was at, everything was at it was much higher and it declined literally every quarter - every month of every quarter throughout the year all the way into December and it continue to decline even in December from one of the raw materials which is what was driving our LIFO credit to grow.
Also then we are getting the benefits of that because that's now what is in our inventory. So, as we go into 2016, we do have lower cost inventories than we came into 2015 was. So we have that benefit too.
But if you compare to fourth quarter, as we indicated we had nearly $99 million LIFO credit in the fourth quarter that's reflecting as you’re adjusting the values of your inventory to a last in first out basis, giving some of that a little bit higher benefit in the fourth quarter. But if you look forward, if raw materials didn’t change then lot other factors of those don’t change your volumes et cetera, than you will be getting rid of most of that LIFO credit.
So for some reason it's still a bit of a mystery to me. I was really just trying to get a dollar number like $168 million includes say $50 million, I think is what maybe I heard $50 million of LIFO related credit that if nothing else changes kind of goes away in the first quarter, so $168 million, we got $118, am I misinterpreting that or not?
I don’t know I would say - be able to split it, I mean it’s not a simple calculation to say how much of it is carrying forward and you get the benefit of lower cost, I would say is that we continue to see lower cost. We see coal cost going down next year, the calendar year contracts we’ll have – what we paid for coal for example this year we will use that inventory up as it floats through all of our systems and then start having lower coal cost coming for example.
So, we will get those benefits iron ores continue to fall, the IODEX has continued to decline. So we get those benefits and then scrap – scrap has actually started to uptick a little bit which if that doesn't usually the interest spot market pricing start to move up also.
So it’s not an easy one to estimate in this split out in the way you’re asking.
Thank you. And our final question comes from Melissa Tan of R. W. Pressprich. Your line is now open.
Hi everyone. Thanks for taking my question. First one is relating to the Ashland blast furnace, just trying to understand, I guess your expectation for 2016 is a fair to assume that Ashland will be on idling for remainder of 2016 and if that’s the case, how would you expect to manage your minimum nominations from your suppliers that's for iron ore and coke because you do get a benefit from the pricing side I think from a volume standpoint you are tied to minimum number every year?
Sure, I will take that one. From a Ashland operational standpoint, we currently have the assumption based on what we tied to our cost that we hit when we idled it – that we took when we idled it that their current view would be is temporary idle for the remainder of the year. That does not mean that will be the case, it will be an evaluation that we do on an ongoing basis in reviewing the iron ore price, the raw materials prices of the imports and where you really have no set number, it’s simply a factor of we would need to have a support sustained profitability in order to resume operations in Ashland and so that remains to be determined type of question.
And as far as raw material portions, it is still work in progress as you mentioned. We have take-or-pay with every aspect of our contracts for raw materials. However we have a lot more flexibility than we’ve had in the past or probably we ever had.
And so we’re continuing to work with our providers of those raw materials and are making adjustments accordingly and working with them to see our way through that.
Okay, thank you. And second one just regarding question on your liquidity, you talked about you are comfortable with $700 million liquidity definitely - if you cover your expense in 2016 and beyond but you also mentioned what other liquidity enhancing metrics are you looking there at this point?
There are things that we can do both from the accounts receivable side and even from the accounts payable side to enhance liquidity. And also the primary focus is on inventory making sure we keep inventories aligned with market demand. Those are some of the actions that we can take and we will continue to make.
And ultimately we are also striving to improve our earnings and lowering our cost. I mean that’s what how you get the old-fashioned way of getting high cash generated from the operations and that’s our key focus of our entire management team.
And as we mentioned back to one comment that David had asked earlier, when you look at the raw materials we did get the benefit of raw materials declining throughout 2015 so as you go into second half David, we were benefited some lower raw material cost there throughout the year and that will carry over in the next year.
So, with that on behalf of the entire AK Steel management team, I would like to thank you for joining us in today's call. I can assure you that we will continue to take on the challenges head-on and focus on adding value for our bondholders and shareholders. And we look forward to providing you with an update of our continued progress next quarter. Thank you.
Ladies and gentlemen, this concludes our conference call for today. Thank you for participating and you may disconnect at this time.
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