Reading the Steel Rally: US Steel Stocks in April
Risk-reward ratio
As discussed in the preceding part of this series, AK Steel Holding (AKS) is trading way above its consensus one-year price target. This seems to suggest that not many analysts are of the opinion that AK Steel’s recent rally is backed by solid fundamentals. It would, therefore, be prudent to look at the different risks and opportunities associated with AK Steel.
Leverage
Analysts have obvious reasons for not liking AK Steel. The company has a negative net worth, and the debt on its books is more than three times its current market capitalization. Those are pretty dangerous metrics to have, especially in an industry that’s facing severe headwinds. High leverage is thus a major risk for AKS investors.
By comparison, Nucor (NUE) and Commercial Metals Company (CMC) have relatively lower leverages, as you can see in the graph above. But then like AKS, U.S. Steel Corporation (X) and ArcelorMittal (MT) have high leverages, though ArcelorMittal is trying to reduce its debt levels by selling non-core assets. MT also has fresh equity through its $3 billion rights issue, and the company has suspended its annual dividend (SDY) program.
Faltering car sales?
While AKS has high leverage ratios, the company faces no near-term debt maturities and has significantly fewer cash requirements this year as compared to 2015. Also, AKS is among the biggest benefactor of rising flat-rolled steel prices in the US.
However, we saw disappointing car sales in March. If US auto sales falter after growing steadily for the last few years, AK Steel could be negatively hit as the company gets more than half of its revenues from automobile customers. Moreover, AK Steel is currently trading above its long-term valuation multiples. This would mean that earnings need to improve considerably to justify the stock price surge.
Overall, the risk-reward ratio for AK Steel now looks troubling after the big surge in stock prices. By comparison, U.S. Steel has seen big appreciation this year. In the next part of this series, we’ll explore what Wall Street thinks about the company.
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