Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
The good news for AK Steel (NYSE: AKS) investors began in the middle of last month, when CEO Roger Newport was reported to have placed an order to buy 10,000 of his own company's shares at a $4.03 strike price. The news has only gotten better since.
For a man earning $3.4 million a year running AK Steel, Newport's insider purchase (worth just over $40,000 at the time) wasn't a huge risk, but it's already earned the CEO a 3% return in less than a month (about 36% annualized). Perhaps more importantly, it appears to have caught Wall Street's attention -- and over the past three weeks, AK Steel stock has been upgraded three separate times, by three separate analysts.
Here's what you need to know.
AK Steel stock looks red hot. Image source: Getty Images.
Morgan Stanley upgrades
Morgan Stanley was first in line to react to Newport's insider purchase with an upgrade. On August 27, StreetInsider.com reported that the investment banker had upgraded AK Steel shares from equalweight (hold) to overweight (buy), with a $5.50 price target. (AK Steel stock costs just $4.16 as of today, implying that Morgan Stanley sees 32% upside in the shares.)
What has Morgan Stanley feeling so optimistic?
The upgrade doesn't start out well. "Guidance has been disappointing and fears around equity issuance haven't gone away," concedes Morgan Stanley -- which may explain why it cut its target price on the shares from a previously hoped-for $6 a share. And yes, with AK Steel carrying $2 billion in net debt on a market cap of only $1.3 billion, the company may ultimately decide it's a good idea to sell some stock to raise cash with which to pay down debt, even if that dilutes existing shareholders a bit.
Nonetheless, Morgan Stanley argues that AK Steel at $4 and change offers "a good entry point," and the reason is rising steel prices. Over the past six months, TradingEconomics reports that steel prices have risen by nearly one-third in price. Currently, AK Steel stock is unprofitable. But because "~60-70%" of AK's steel output is sold on contract, and 25% of that contracted output will reprice higher in Q4 of this year, with a further 50% of that contract volume repricing shortly thereafter -- in Q1 of 2019 -- Morgan Stanley believes AK Steel stands to start reaping much higher profits in a very short period of time.
Merrill Lynch seconds
Next in line to upgrade AK was Merrill Lynch, which on Friday did a 180-flip in its thinking on AK Steel, upgrading the stock from underperform to buy -- and assigned the same $6 price target that Morgan Stanley had just abandoned.
From a benchmark price of $700 per ton in 2018, Merrill sees hot-rolled coil steel rising to $750 a ton in 2019. Merrill sees as much as 85% of AK Steel's "sheet business" in particular repricing to enjoy the higher prices between now and the end of 2019. Merrill also believes AK Steel will see a "substantial" increase in profits next year, as TheFly.com reports, helped by increased demand for steel from new oil and gas projects.
Completing the trifecta
Finally, just this morning, AK Steel saw its third upgrade in two weeks, when Norwegian banker Clarksons Platou chimed in with an upgrade of its own.
Echoing Merrill Lynch's $6 price target, Clarksons added that AK Steel also stands to benefit more than most from "the upcoming 2019 annual auto contracts" to supply automakers with the steel they need. Current automotive steel prices are "well below market, says the analyst, and will rise to award AK fairer profits on its products.
This, argues Clarksons, should allow AK Steel "to disproportionally benefit versus peers" -- and give its investors a chance at earning as much as a 44% profit on the shares.
The upshot for investors
As you can see, there's a lot of optimism about AK Steel stock on Wall Street lately. That being said, an investment in AK Steel is anything but a sure thing. As already mentioned, AK Steel carries a huge amount of debt for a company of its size. At $2 billion net of cash on hand, AK's debt load is 50% as big as its own $1.3 billion market capitalization.
On the other hand, if AK's balance sheet carries "risk," the stock also shows some serious "opportunity" for profit on its income statement. In addition to the positive prognostications already posted above, analysts surveyed by S&P Global Market Intelligence predict that after losing money last year, AK Steel stock will turn profitable -- massively so -- this year, earning $0.72 per share by the end of 2018, and growing that profit 30% to $0.94 in 2019. Should it hit those profits targets, AK Steel at $4.16 per share today is selling for just 5.8 times the profits it will earn by year end -- and just 4.4 times the profit it will earn next year.
Those aren't bad multiples to earnings at all, especially not with analysts positing a better than 21% annualized earnings growth rate for AK Steel stock over the next five years. When combined with positive trends in free cash flow -- AK has generated positive cash profits for the past three years straight -- and the potential for AK to use that cash to pay down its debt (long-term debt levels are down 16% over the same period), I think there's at least a possibility that Wall Street is right this time.
AK Steel stock really might be a buy.
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