If you're a value investor, you might be interested in one of the more beaten-down sectors of the market: industrials, particularly U.S. steelmakers. In the first half of the year, U.S. steel prices plummeted as the lingering U.S.-China trade war stoked recession fears. At the same time, iron ore, a critical steel input, spiked in price following the Brumadinho Dam disaster in Brazil in January. That has squeezed the profits of steelmakers all around the world, including U.S. steel company AK Steel (NYSE: AKS).
Despite already falling 45% over the past year, the investing community still isn't optimistic about the company's future -- AK Steel's PE ratio is just 4.5.
Yet could today's fears be tomorrow's opportunity? While AK Steel gets a bad rap for being in an unexciting "old" economy business, the company is rapidly innovating in order to meet the future needs of steel customers, especially the auto sector. Here are the moves this steelmaker is making, and how the business could look a few years out.
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Dangers, or opportunities?
One of the main risks for AK Steel is that it generates almost two-thirds of its revenue from the North American auto market, and two major customers -- Ford (NYSE: F) and Fiat Chrysler (NYSE: FCAU) -- account for more than 10% of its revenue. That level of concentration means that the company could be vulnerable to turbulence in the auto sector.
As many know, auto stocks are somewhat controversial these days. For one thing, the sector is very cyclical, meaning if a recession hits car sales (and thus steel demand) will plummet. Second, the auto sector is facing a fair amount of disruption from both electric vehicles and the ride-hailing industry. Today, electric vehicle motors are often imported from other countries, and don't use AK Steel's bread-and-butter carbon steel.
Finally, even traditional autos are subject to the federally mandated CAFÉ fuel standards, which mandate that U.S. autos must achieve 54.5 mpg by 2025. That could cause auto-makers to use less steel, or alternatives such as aluminum. In fact, AK Steel noted in its recent annual report that one major automaker recently substituted aluminum for steel in the frames of some of its recent models.
How AK is adapting
But AK Steel isn't idly standing by. It has taken several decisive steps to innovate at a rapid pace and stay relevant, including:
Advanced high-strength steel: While some might think all steel is the same, there are a number of ways steel companies can mix materials, creating advanced-engineered alloys to improve certain factors. AK's third generation NEXMET advanced high-strength steel (AHSS) offers increased flexibility and significantly better strength than older steel generations. These superior properties allow engineers to design thinner and more lightweight parts for vehicles without cutting corners on safety requirements. Newer innovations like AHSS, which is just hitting the market, could help ward off the threat from aluminum.