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Why AK Steel’s Profit Margins Might Not Expand Much in 2Q16

What's Looming ahead for AK Steel in 2016?

(Continued from Prior Part)

AK Steel’s profit margins

In the previous part, we discussed how AK Steel’s (AKS) margins, as measured by the per-ton EBITDA (earnings before interest, taxes, depreciation, and amortization), have fallen in 1Q16 as automotive contracts rolled over at lower prices.

Meanwhile, spot steel prices have recovered sharply, which we’ll eventually see in AK Steel’s contract pricing. But the company does not expect a major margin expansion in 2Q16. Let’s discuss why.

Raw material costs

AK Steel sources iron ore from third parties based on the Vale (VALE) model, which has a four-month lag to spot iron ore prices. Thanks to falling iron ore prices, AK Steel has reported a LIFO (last in, first out) credit in the last several quarters.

However, iron ore prices spiked in 1Q16. Although the benchmark iron ore contract lost some of its recent gains, as can be seen in the graph above, it is still up handsomely on a year-to-date basis. AK Steel did not provide a watertight figure, but it still expects a LIFO charge in 2Q16. According to AKS, the charge should be less than $10 million.

Advantage of integrated steel mills

Because of the pricing lag, AK Steel’s raw material costs will likely go up in 2Q16. Integrated steelmakers like U.S. Steel (X) and ArcelorMittal (MT) stand to gain from higher iron ore prices because these companies also mine iron ore along with their steel production operations. Notably, MT and X got punished last year because of their integrated operations. As iron ore prices have shown some strength this year, both these companies stand to gain from it.

Notably, Nucor (NUE) mainly uses steel scrap to produce steel and could also see its unit production costs rise in the coming quarters.

In the next and final part, we’ll explore how are markets (RZG) are currently valuing AK Steel.

Continue to Next Part

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