This Steel Stock Is Not Out of the Woods Yet

Vladimir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Despite the fact that steel is one of the most important products in modern civilization, this year has been tough for steel makers as steel prices have remained low. AK Steel (NYSE: AKS), which is down 25% this year, recently reported its quarterly earnings. The company beat analysts’ estimates, but the difficult period is far from over. Here’s why.

Little progress

AK Steel reported a net loss of $40.4 million. The biggest part of the loss was $22 million in planned outage costs on one of the company’s facilities. Another $6 million of unplanned outage costs added to the loss. Revenue was up 3% from the previous quarter.

The main factor -- the price of steel -- remained almost unchanged. While the average selling price per ton of steel was $1,062 in the first quarter, it was $1,061 in the second quarter. AK Steel has stated that continuing strength in the automotive market supports the price. However, it has not led to a rise in price. The automotive sector contributed to 50% of revenue in the first half of the year.

AK Steel finished the quarter with $58.4 million of cash on hand, down 70% from $191.8 million at the end of the first quarter. Debt and pension obligations continue to be a significant problem for the company. They are the main reasons why stockholder equity is negative.

Steel prices under pressure

AK Steel gave relatively little comment on steel prices during the earnings call. This was not the case for Nucor (NYSE: NUE), which blamed imports for the low prices. The company has stated that imports continue to put pressure on margins. The dumped prices disrupt the marketplace. Nucor said that China had over 200 million tons of estimated excess steel production capacity. This fact puts additional pressure on prices, which so far have been under pressure.

Nucor is the only steel producer in U.S. to enjoy an investment grade credit rating. Others, like United States Steel (NYSE: X), are not so lucky. The company would be reporting its earnings at the very end of July. So far, the stock is down 21% this year. The company is estimated to lose $0.79 per share in the second quarter. Just three months ago, analysts were expecting a $0.23 profit. This is a vivid example of how fast the estimates change when things go wrong. The steel prices did not rebound at all, and in this business, price is the most important factor.

What’s in the future?

Steel manufacturers continue to be pressured by the low price levels. This is not something they could change. This fact brings significant uncertainty to the investment process. At the same time, it’s worth noticing that the $468 million capitalization of AK Steel is less than $677 million of inventory that was on books at the end of the second quarter. It’s the debt and pension obligations that spoil the picture.

Nucor is trading at a forward P/E of 13, but earnings estimates tend to shrink as the rebound in steel prices is postponed. U.S. Steel is trading at 0.78 P/B, while Nucor is trading at 1.94 P/B. The fact that Nucor is profitable causes the stock to trade at a significant premium to its peers. So far, the current price level is what worries investors in steel stocks the most. 

Bottom line

The question of putting your money in AK Steel, or Nucor, or U.S. Steel is about whether you believe that steel prices would rise. There is overcapacity in the market. There is a slowdown in China and continued weakness in Europe. On the other hand, this is not eternal, and at some point, the prices would appreciate.

AK Steel greatly depends upon the price of steel. While Nucor is still profitable at current levels, AK Steel is not. There is no driver to push the steel prices up in the near term, so my bet is that AK Steel would continue to fluctuate back and forth. This is also true for U.S. Steel. As for Nucor, the company needs better prices, too, to show positive movements.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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