AK Steel Holding Corp. (AKS) and Steel Dynamics Inc. recently reported third quarter earnings. We have a bearish view on steel fundamentals in the U.S. in the near term, and in particular, we have a sell rating on AKS. AK Steel, in our opinion, will continue to see pressure on its margins. AK Steel has a highly levered balance sheet and it has total cash of $37 million and total debt of $1.28 billion. Its YTD net debt has surged by $486 million. Depressed stainless steel market conditions and weakness in the historically lucrative electrical steel market is adding to AKS' woes.
However, we believe Steel Dynamics, Inc. (STLD) (minimill), being one of the most vertically integrated steel makers in the U.S., is well positioned to benefit from a rebound in steel demand. Steel Dynamic Inc, like AKS, continues to operate in challenging conditions, but due to handsome margins, diversified product mix, and pipeline of growth projects, the company is in a much better position. Keeping in mind the weakness in SBQ (special bar quality) demand, STLD's results continue to be resilient. We expect results to improve further in 2013, mainly driven by a recovery in scrap prices and steel demand. We have an equal weight rating on STLD in the near term, but we are bullish in the long term. Low scrap prices should help steel operations and metal margins. Moreover, residential construction is also showing positive signs. STLD's fabrication business has shown amazing improvements YoY and QoQ. STLD also offers a handsome dividend yield of 3.1 percent.
AK Steel Holding Corp::
AK Steel produces flat-rolled, tubular, stainless and electrical sheets at its primary operations in the U.S. and internationally. Construction, automotive, power distribution and appliances, and industrial machinery and equipment serve as AKS' primary markets. Distribution service centers and converters accounted for 40 percent of AK Steel's 2011 sales; automotive was the second biggest customer with 36 percent of the sales.
3Q Earnings Review:
AKS reported 3Q adjusted loss of $0.25 EPS, better than both the consensus loss of $0.37 and mid-quarter guidance of a loss of $0.34-$0.39. However, AKS reported a loss of 3 cents for the same quarter last year. The consensus/guidance beat was largely attributable to $27.5 million LIFO tax credit, which made an impact of roughly $0.16.
Shipments were up 2.1 percent QoQ to 1363.5 (000 tons) from 1336. Average realized prices were down 6.8 percent sequentially and 7.3 percent YoY. Net sales were down 5 percent sequentially and 7.7 percent YoY.
AKS stated that they expect more red ink in 4Q, including a non-cash tax expense related to an anticipated change in tax valuation allowance. The weak internal and external demand, which has depressed steel prices, is also adding to AKS' woes. 3Q also included $28.5 million in planned maintenance costs, which are unlikely to recur in 4Q.
Steel Dynamics Inc:
With an annual capacity of 6.3 million tons, STLD operates five steel minimills in North America. Flat-rolled products and sheet steel accounts for approximately 50 percent of the capacity, and long products such as channels, beams, and bars take up the rest of the capacity. The company also engages in upstream businesses such as production of scrap substitute and scrap collection. The company has three main reporting segments; steel operations, metals recycling and ferrous resources, and steel fabrication. More than 60 percent of STLD shipments are flat-rolled steel sheets.
3Q Earnings Review:
STLD reported 3Q operating adjusted EPS of $0.15, above both consensus EPS of $0.13 and guidance range of $0.09-$0.14. The adjusted EPS excludes one time refinancing charges of $0.07 and impairment charges of $0.02.
Operating Highlights Steel Operations:
Shipments were down 7.6 percent sequentially to 1.41m tons. Operating income for the segment was also down 21 percent QoQ. However, both average sales price per ton of $809 and average cost per ton of $352 were better than sell-side expectations, resulting in a margin per ton of $457.
Metals Recycling & Ferrous Resources:
Though profits for metals recycling improved sequentially, the segment is still in red ink. Profits were more than offset by Mesabi Nugget (81 per cent owned by STLD), which reported a loss of $11 million and is expecting the same results for 4Q. The combined segment reported a net loss of $9.5 million up 28 per QoQ. Metals recycling alone reported operating income of $16.5m or $25.9m, excluding unrealized hedging losses.
The fabrication segment reported excellent results, with operating income increasing to $3.1 million from $0.2 million in Q2'12. Total shipments increased 3 percent sequentially, whereas the average sales price per ton increased by 4 percent.
STLD remains cautious on the near term outlook, the company sees softening in areas related to natural gas exploration, such as agriculture and transportation. However, manufacturing and auto remains strong with residential construction showing signs of life.
The company believes the scrap market is oversupplied; however, the bottom is near for scrap prices.
STLD is trading at a forward P/E of 9.77x against AKS' forward P/E of 9.52x. STLD's PEG ratio is 2.02x, while AKS has a negative 0.7x PEG ratio. Both operating and profit margins of STLD are significantly higher than AKS, which has reported negative profit margin of 15.2 percent.
Nucor Corporation (NUE)
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