U.S. steel companies have been benefiting from higher prices, partly due to protective steel tariffs. While it's great news that increasing revenue is lifting the earnings of major domestic steel mills, this is only one piece of the financial equation. In a highly cyclical industry like steel, you also need to watch a company's financial foundation to ensure it can thrive through the industry's down times. AK Steel Holding Company (NYSE: AKS), for example, has been laboring under a heavy debt load but has been working to shore up its balance sheet. Has it made enough progress to justify putting it on a buy list?
A very rough stretch
Over the last 10 years, AK Steel has lost money eight times. In fact, 2017 was the first year the company's GAAP earnings were positive since 2008, bookending the decade span with black ink. The red ink in the years between was caused by low steel prices, asset writedowns, and one-time charges related to a debt overhaul, among other things. Addressing its debts was a necessary step since interest expense went from roughly $47 million in 2008 to a peak of $173 million in 2015.
Image source: Getty Images.
It shouldn't be surprising that long-term debt rose dramatically over that span. In 2008, AK Steel's debt stood at roughly $630 million. It peaked in 2014 around $2.45 billion. If the steelmaker's business were firing on all cylinders throughout this time frame, investors wouldn't have minded the added debt. But AK Steel was losing money as it struggled through a deep industry downturn. Increasing leverage and losses aren't a good combination.
Asset writedowns, meanwhile, pushed shareholder equity into negative territory in 2012, and it hasn't recovered, meaning that long-term debt has made up more than 100% of the capital structure for around five years. That suggests little to no value left for shareholders in a liquidation scenario (an unlikely outcome but not one that can be totally dismissed). Still, the company's balance sheet has been improving.
A change for the better
Fixing the balance sheet was a main goal for AK Steel. By the end of the first quarter of 2018, long-term debt had been reduced by nearly 14% from its 2014 peak. Below that number, the company had refinanced around a third of its debt, pushing out maturities and lowering its interest costs. These are all important milestones and show that progress is being made. But how much?
AK Steel Strategic Progress: Strengthened Capital Structure
-- $680 million of debt refinanced and maturities extended.
-- Lowered annual cash interest cost by ~$20 million.
-- Enhanced and lowered cost of revolving credit facility.
An update on the capital structure from AK Steel's June investor presentation. Data source: AK Steel Holding Corporation.
Shareholder's equity excluding noncontrolling interests was still negative at the end of the first quarter. That means that debt continues to make up more than 100% of AK Steel's capital structure. And while interest expense was lower year over year in the quarter, it still ate up roughly 25% of EBITDA.
By contrast, interest expense was just 5% of competitor Nucor Corporation's EBITDA in the first quarter. Steel Dynamics' interest expense, in the meantime, was around 8% of its EBITDA in the quarter. To be fair, Nucor and Steel Dynamics are two of the most financially conservative U.S. steelmakers, but these comparisons clearly show that AK Steel's debt remains a notable issue and sets it apart from its peers. The company's debt situation is better, but it looks far from fixed.
More work to be done
A rising tide lifts all boats. U.S. steelmakers have all benefited from an improving domestic steel market. However, that doesn't mean that all of the major U.S. mills are worth owning. AK Steel was hard hit during the downturn, partly because of its heavy debt load. It has made progress in addressing that issue, but it remains heavily leveraged relative to key industry peers. Most investors would be better off avoiding AK Steel and sticking to more conservatively leveraged competitors like Nucor and Steel Dynamics.
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