AK Steel: 10 Structural Changes That Should Trump the Business Cycle

Ahhhh, the business cycle, etched so very deep into the collective mind of Wall Street. The business cycle, so very important, so very fundamental, that there is even a category of stocks known as "cyclicals." And conventional wisdom states, "Don't get caught with a cyclical when the business cycle goes south! Cyclical stocks do terribly in the trough of the business cycle. So if you see even a hint that the down side of the cycle is coming, get out, get out. Run for the hills. It's gonna be baaaad. Oh so very, very baaaaaad."

And what could be more cyclical than steel. Sure, when the good times role, we need steel, out of which to build cars and beautiful office towers. But when the business cycle turns south, we don't need very much steel anymore. And then, per conventional wisdom, there is a competitive frenzy between the steel companies and they start going under and fools who have been crazy enough to invest in steel lose all there money. And that's baaad. Oh, so very baad.

Perhaps it is this type of thinking that has caused analysts to rate AK Steel (AKS) at a collective 3.2, where 1 is a strong buy, 5 is a strong sell and the average stock is ranked at about a 2.4. AK Steel has had a rating of about a 3.2 during its entire climb from a little over 2, to 72.

Well, the analysts sure missed the boat on that one. You would have thought that one of them would have had the guts to issue a buy recommendation. But for the most part, not a one of them did. And this has been a fabulously lucrative stock for those who bought, despite the disapproval of the analysts.

And perhaps it is that sort of business cycle thinking that in the last few days has slammed AKS from a high of 70.54 on Monday, June 30 all the way down to a closing price of 52.79, today, July 3rd. Yes, that is a drop of 25% in a little less than four short days. The new orders information released by the Census Bureau showed a very small drop in steel orders from April to May and the auto makers announced dismal sales figures and wham, did AK Steel ever get hit hard. And why not? If this the beginning of a trough in the business cycle for steel, which will represent a harrowing descent for the steel companies, it makes perfect sense.

I am convinced, however, that structural changes in the world economy will continue to boost the fortunes of AK Steel. Sure, it could go down further in this crazy, skittish environment. But, hey, although its course over the next month or two is unpredictable, eventually the fundamentals of the situations will translate to an increased stock price. And what are these structural changes? Well, I discussed four of them in a Marketocracy Marketscope article of April 2005. Now I can think of at least 10:

1. Fossil fuels are being depleted: This is a structural change that will not be reversed. The greater the depletion of fossil fuels the deeper we will have to go to get them out. The greater the complexity of the extraction process, the more steel typically will have to be used. Rather than just drilling down a mile or two and pumping it out, we must drill down a mile or two in a first well, and then drill a bunch of wells around it to inject water or gas or steam to get that oil out. And we must drill more wells, deeper, into smaller pockets of oil and gas. This all takes more and more steel.
2. The huge U.S. trade deficit is not sustainable. We must start to make progress at closing this massive deficit, which is running at about $2,500 per American per year. To do this the dollar must fall. Perhaps not today, or tomorrow, but eventually. As it falls, American steel producers become more competitive with foreign producers. We should also note that the domestic steel industry's nightmare days came at a time when the dollar was worth about 20% more than the Euro. Those dark days are not coming back.
3. The high price of petroleum means that it costs more to ship steel from overseas. As the United States is a net steel importer, this benefits domestic steel producers because it drives up the price of competing imported steel.
4. The high price of petroleum means that petroleum exporting countries are going on a building spree, using a great deal of steel. The Saudis are planning huge new cities. The steel for these cities comes from all over, and it drives up the international price.
5. The high price of natural gas is making alternative means of electricity production increasingly feasible. That means steel supports for windmills and steel structure for solar facilities (a square mile of pivoting mirrors translates to a lot of steel structure).
6. The high price of petroleum creates an advantage for railroads over trucks. This means the railroads will expand their rail network, which is made of steel.
7. The Chinese government used to encourage steel exports, now they discourage them, to keep the steel in China.
8. The agricultural boom means more spending on agricultural structures, made of steel.
9. The high price of gold, silver, copper and other metals means that more steel will be needed for mining equipment, mine structural supports and processing facilities.
10. Our continuing efforts to fight pollution mean that we will use more steel for sewage treatment facilities and pollution control equipment.

So that is ten structural changes that will cause steel to continue to prosper. U.S. Steel (X) is good also, but AK Steel, with its 3.2 analyst rating and its recent 25% price plunge, is the underdog that I love. It may take another two months for it to bottom out, or it may have hit bottom already. There is just no telling with investor psychology. But I foresee that this stock has some more strength and will be moving back up, before too long.

Disclosure: I own AK Steel, myself, and I also own some in my mFolio portfolio.

Comments

[CLH:]

All materials go by cycles. When I read articles like the above, I know the turn down cant be far off. The above article can be classed as a "Its different this time" post.

2008 Jul 06 10:47 AM

[FLLLL:]

You cannot own Arkansas Steel.
The stock you own is AK Steel

2008 Jul 06 12:35 PM

[elmatador:]

Economic cycles don't exist but are attractive because it creates order. It is ramdomness governs economics. The idea that economy moves in cycles is atractive since governing elites feeds to the ignorance masses that the difficulties are temporary.

2008 Jul 06 01:10 PM

[Steel Marke...:]

Steel stocks are running scared as analysts discover not all mills were able to obtain the higher prices as analyst were led to believe. You can read about this subject and other steel related subjects on my newsletter - Steel Market Update - steelmarketupdate.com. I will have a new article on the subject in Monday's edition. You can register online for a free trial.

2008 Jul 06 03:46 PM

[Timothy Siegel:]

Fllll, point well taken. I just think of them as Arkansas Steel because that was the name when I first started buying in.

Steel Market Update, Still, hasn't the market reaction been a little overdone? A 25% drop on one piece of bad news, that might not even be that bad??? The point is that so many shareholders are ready to sell at the first sign that there will be a downturn.

2008 Jul 06 09:32 PM

[Jake2:]

Steel Market Update: just went to your website. Nothing there but a promo to sign up. I didn't.

2008 Jul 07 01:17 AM

[fxtrader07:]

@CLH: that#s the old us-centric view of the world. of course, all materials went through cycles and will do in futre, as well. the question, though, is: what kind of cycle? or will it be a couple of cycles thorughout the world that may increasingly overlap each other and diverge? infrastructure buil-ups of huge dimensions are takinmg place in Chindia, the middle east and russia over the coming years. a u.s. recession won't stop that anymore. in fact, the u.s. lacka n infrastructure build-up and repair/maintenance so baldy, it may well be chosen as a programme by the new administration to get over recession/stagflation. or they may delay that for another 4 or 8 years which could mean that by the time chindia and co. are more or less done, the u.s. will start using a lot more steel than today. It is funny to see how often the "one cycle for all" assumption is adopted without questioning - yet, the oil price already proves that this is a doubtful theseis to start with.

2008 Jul 07 05:27 AM

[FLLLL:]

AK Steel was never ARKANSAS STEEL.Originally it was ARMCO.
Then Kawasaki got involved. In the end it became A(rmco)K(awasaki)
Steel.

2008 Jul 07 06:49 PM

[Timothy Siegel:]

Thank you, FLLLL. I'm glad I know that history now. As Mark Twain said, "It's not what you don't know that will get you into trouble, it's what you know for sure that just ain't so." I don't discuss these things with many people who are knowledgeable, so after I read the "AK" as Arkansas (and it's actually the postal abbreviation for Alaska), I just went blithely on, uncorrected. Seemed strange that they always abbreviated it and had no facilities in Arkansas, but after once forming the belief, it was so easy to continue. Now I'm glad I know the truth.

2008 Jul 08 05:20 PM

[Timothy Siegel:]

Fxtrader, you and I think in a similar way. I remember watching CNBC, last year, and hearing an analyst say that the recession would likely drive petroleum prices down. I was aghast, because it seemed that to this fellow the U.S. was the world. "We are the world," some think. And right after WWII, there was some truth to that. The US represented a huge share of the world economy. But it sure is not true any more.

2008 Jul 08 05:23 PM