AK Steel’s Raw Materials Strategy Offers Significant Cost Reductions

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West Chester, Ohio-based steel producer, AK Steel (NTSE:AKS), is expected to begin benefitting from the company’s improving raw material positioning in 2014, with full impact in 2015. The integrated steel maker is expected to benefit from the declining iron ore costs through the year. Costs will be higher in 1Q14 due to lags and the strength in spot prices; however, as the year progresses, prices are expected to decline. Starting in 2Q13, the company will also begin to see benefits of its renegotiated iron ore pellet contract with CLF. AKS’s pellet facility with Magnetation could also start up in late 3Q14, well ahead of its early 2015 timeline.

Lower coal and coke prices are also expected to save the company $70 million in 2014, with benefit beginning in 2Q14. Overall the company’s EBITDA is expected to improve by 75 percent or $186 million due to lower raw material and outage costs. Finally, the tailwind from lower pension liabilities was significantly higher-than-expected, AKS’s combined pension and OPEB declined by $719 million in 2013. Lower liabilities and lower funding requirements beginning in 2015, should drive multiple expansion for AKS.

AK Steel reported adjusted 4Q13 operating EPS of $0.09, beating consensus estimates of $0.02 by a handsome margin. The company did not only beat consensus estimates but results were also better than AKS’s own guidance range of $0.02-$0.06 per share. The headline EPS of $0.26 included a non-cash income tax credit of $22.7 million or $0.17 per share. Both higher than guided average unit selling price and shipments largely drove the beat. Adjusted EBITDA of $87 million came in below consensus estimates of $92 million.

Shipments totaled 1.42 million during the fourth-quarter, while selling prices averaged $1,031 per ton. The company reported 4Q13 operating profit per ton of $33.There was a LIFO credit of $4.3 million during the quarter. 4Q13 results included $4.3 million, or $0.03 per share, of charges related to the unexpected furnace outage at the company’s Middletown Works facility. No significant costs from this outage are expected in 2014.

Lower Pension and OPEB Liabilities in 2014

AKS is expected to benefit from lower pension and OPEB liabilities in 2014. In addition to lower coal prices, the company also sees a tailwind from the completion of charges related to the Middleton outage. The company will provide further guidance on 1Q14 this month. Due to cash payment of $285.3 million, strong asset returns, and higher discount rates, AKS’s pension and OPEB liabilities declined by $719 million in 2013. The more important thing is that the reduction in liability was significantly greater than the market expectations.

Conclusion

AK Steel is going through a major transition that would permanently improve the company’s cost structure and allow it to be profitable through the cycle.The West Chester, Ohio-based company is a highly leveraged blast furnace/basic oxygen furnace focused steel producer that offers a high beta (2.34) way to play the macro story and the inevitable cyclicality of the steel industry.

In the long-term the company is well-positioned to benefit from declining raw material prices and from its iron ore and metallurgical coal projects. AKS’s Magnetation JV is expected to reduce costs by $90 million annually. In the near term, weaker spot iron ore pricing should begin to flow through in 2Q14; however, higher natural gas prices have the potential to offset a portion of these savings. Although the company’s raw materials strategy offers potential for some cost reductions over the next few years, the execution of the strategy is sensitive to the state of commodity markets.

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