AK Steel (NYSE:AKS) reported a better than expected $0.43 per share loss ($0.75 expected). Despite beating estimates, the stock dropped over 5%. It is clear profit-taking played a role in the sell-off, but the current valuation is the primary reason the stock is dropping and will likely continue to do so.
AK Steel currently trades at around 19x forward 12-month EV/EBITDA and 8.5x EV/EBITDA 2010E. It is rational to pay a higher-than-average multiple for a cyclical company's trough earnings, but AK Steel's electric steel strength indicates that the earnings base is not truly at trough levels.
In addition, AK Steel faces an uphill battle on the following fronts:
- The auto industry remains weak, and the recovery will likely take years, not quarters. Even if the market rebounds, auto contracts are low margin for AK Steel
- AK Steel faces competitive pressures from US Steel's new carbon capacity in 2010.
Overall, AK Steel is priced for perfection. If either the steel market or the global economy surprises on the downside, AK Steel could revert to a more realistic multiple.
Currently, the lower end of sell-side analysts' price targets is $12, which I view as too low. However, shorting AKS in the $19-21 range could yield 20-30% in the short or intermediate term.
Disclosure: The author has a short position.