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Morningstar | AK Books Higher Profits and Reduces Pension Liability in 2018, but We See Margin Contraction Ahead. See Updated Analyst Note from 29 Jan 2019

Although AK Steel grew profits and reduced leverage in 2018, the company has more work ahead if its market share is to stabilize. Full-year adjusted EBITDA rose 6.6% to $563 million. Although this represents a healthy increase, it comes amid favorable market conditions for steel prices and metal spreads. As such, the company's key competitors were, by and large, able to usher in more significant profit growth on a relative basis.

For AK Steel, our base-case modeling assumptions continue to imply zero equity value. Therefore, our fair value estimate is driven by option value tied to a 25% weighting toward our bull-case fair value estimate. Having trimmed our bull-case fair value to $13 per share from $15, our base case fair value falls to $3.25 per share from $3.75. Our no-moat rating remains intact, as we expect the company to fall well short of its long-term return on invested capital target above 10.5%.

Granted, our long-term outlook for the broader U.S. steel industry is bearish relative to consensus expectations. We forecast that steel prices and metal margins will decline in 2019 and remain lower for longer thereafter. This will be driven by weak fixed asset investment growth in China and the persistence of global overcapacity. Due to the company's elevated financial leverage, AK Steel's equity value is highly sensitive to our forecast for lower free cash flow beyond 2019.

In 2019, we forecast adjusted EBITDA of $504 million versus management's guidance to a range of $515-525 million. For adjusted earnings, we forecast $150 million versus guidance to a range of $160-180 million. On revenue of $6.7 billion in 2019, we forecast a 7.5% adjusted EBITDA margin. However, by 2023 (midcycle), our adjusted EBITDA forecast falls to only 5.7%. This falls shy of management's long-term target of 8%.