Billionaires Betting On Small Steel: AK Steel (AKS) Versus United States Steel (X)

We see the downward pressure as a possible buying opportunity, where the future turnaround in AK’s operations should help drive earnings growth. The steel stock’s valuation remains low despite a positive earnings outlook. The steel company has managed to meet or beat earnings each of the last four quarters and is expected to have an annual EPS growth rate of 27% over the next five years – the best CAGR of all five steel stocks. One of AK’s initiatives is to invest heavily to internally generate half of its iron ore and coal requirements, with plans to start mining for coal in the first half of 2013. AK Steel is also looking to better penetrate higher margin businesses, including carbon, stainless and electrical steel.

AK trades at only 0.1x sales, compared to US Steel at 0.2x. Assuming AK should trade more in line with the steel giant, given similar debt loads (both with debt-to-asset ratios of 25%) and an expected rebound in profitability, the steel stock could see upwards of 100% upside based on 2013 sales estimates.

What’s holding major competitor Steel Dynamics back is that a big portion of the company’s revenues (40% for the first nine months of 2012) are derived from the struggling rail industry, and not the auto and construction industries. This duo is where the majority (80% for the first nine months of 2012) of AK’s steel products shipped. Steel Dynamics does pay a reasonable dividend at 2.9%, but its valuation – 11x forward earnings – and growth – 8% 5-year expected EPS CAGR – are nothing to get excited about. Billionaire George Soros was selling off his entire stake of Steel Dynamics last quarter (see George Soros’ latest picks).

Ternium, meanwhile, is a Latin American steel company that derives almost 45% of its revenues from outside of North America. ArcelorMittal is another non-U.S. based steel company, but we continue to prefer the U.S. steel companies to these two operators, given that the expected robust steel demand should be driven by the auto and construction markets in North American. Ternium does pay a solid dividend yielding 3.2% and has a cheap valuation at 8x forward earnings, but recent guidance puts operating income for 4Q lower than expected due to lower average prices and higher operating costs. Steve Cohen of SAC Capital sold off his entire stake of Ternium last quarter (check out Steve Cohen’s biggest bets).

ArcelorMittal’s also pays a robust dividend yielding 4.3%, but it has an expensive valuation at 19x forward earnings. Recent news shows the company boosting its already robust ($2.9 billion) cash position with the sale of a $1.1 billion stake in one of its Canadian iron ore mine operators. Ken Griffin – founder of Citadel Investment Group – sold off 90% of his ArcelorMittal shares last quarter (check out Ken Griffin’s new picks).

To recap: AK trades at the very low end of the industry on a P/S basis, but has some of the more robust growth prospects. We see AK as one of the potential big benefactors of a rebound in the steel industry. Read more about other industries you can profit from:

Steel Dynamics: Is This Dividend Stock A Steal?

How to Profit from the Copper Turnaround in 2013

A Deeper Look At Brazil’s Commodity Industry

Disclosure: I have no positions in any of the stocks mentioned above

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