AK Steel Holding Corporation (AKS), Nucor Corporation (NUE), Steel Dynamics, Inc. (STLD): Is There A Bright Spot In This Industry?

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AK Steel Holding Corporation (AKS)The steel industry has been going through a “prisoner’s dilemma.” No single company is willing to reduce its production, and as a result, all players in the industry are suffering from the overcapacity syndrome. In this situation, can we still find attractive players in this industry? Let’s have a look.

AK Steel Holding Corporation (NYSE:AKS) exited 1Q13 with total liquidity of ~$1.05 billion, largely unchanged vs 4Q12. However, with capital spending likely set to ramp up, and with the Q1 results reflecting the lower iron ore prices that existed in late 2012, the cash burn will increase in the coming quarters, barring a sharp rebound in steel demand/margins.

Nevertheless, the dilutive transactions in late 2012 sufficiently shored up AK Steel Holding Corporation (NYSE:AKS)’s liquidity to bridge 2013 to 2015. Also, the stock has some cheap valuations. Underlying the liquidity concerns is a stock that is trading at 5.9 times 2013 EBITDA estimate, and 3.7 times 2014 EBITDA estimate, well below the peer group averages of 7.1 times and 5.4 times, respectively. Further, if (it is a big “if”) steel industry fundamentals improve over the next 12 months (Barclays is pretty positive that it will), AK Steel Holding Corporation (NYSE:AKS) shares are the most leveraged to this recovery, considering the large current investor overhang toward the shares (the stock is down 20% since the start of the year) and the company’s underlying operating leverage.

Over time, AK Steel Holding Corporation (NYSE:AKS)’s efforts to increase its raw material integration into iron ore and met coal will provide more stability to the company’s earnings, which have been squeezed by elevated raw material costs over the past several years. However, in the shorter term, these investments, and the company’s cash pension requirements, will suppress the company’s cash flows, especially in an environment of weak steel prices and even lower raw material costs in 2013.

A tough call for this steel stock

For long, Nucor Corporation (NYSE:NUE) has remained my favorite steel stock. Nucor Corporation (NYSE:NUE)’s results will continue to improve, in conjunction with the expected recovery in construction-related demand. However, given that the stock is up more than 20% for the year, this expected recovery seems to be already factored into the shares, and we are yet to see meaningful, tangible evidence that the recovery is underway.

Nucor Corporation (NYSE:NUE)’s Direct Reduced Iron (DRI) technique of producing steel has received praises from some big shots on the Street. This process uses a prodigious amount of natural gas to create iron by heating the iron ore at a temperature high enough to burn off its carbon and oxygen content.

Similarly, while DRI is an important cost-savings opportunity for Nucor Corporation (NYSE:NUE), the expectations for the magnitude and timing of the contribution for Nucor are more likely to prove overly optimistic than conservative. With Nucor Corporation (NYSE:NUE) shares trading at 9.8 times 2013 and 6.4 times 2014 EBITDA estimates, much of the positive outlook is factored into the shares.

Despite falling finished steel and scrap prices thus far in Q2, consensus estimates call for a 48% increase in Q2 EBITDA vs. Q1, and another average increase of 20% in Q3 and Q4 vs. Q2 (remember, Q4 is typically the seasonally soft quarter).

There are high chances that results should improve, but this is a fairly steep slope to climb for a company that has historically demonstrated meaningfully less earnings volatility than its integrated steel peers, even after considering the expected positive impact associated with DRI. Hence, a neutral stance is given on this stock.

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