Morningstar | AK Steel's 2Q Results Fall Short of Margin and Volume Guidance; Shares Plummet Yet Still Overvalued
AK Steel reported soft second-quarter results, as the company was unable to achieve management's guidance for both adjusted EBITDA margins and shipment volumes. Shares traded sharply lower on the news. Having tempered our near-term profit outlook for no-moat AK Steel, our fair value estimate falls to $3.75 per share from $4.25. Although we've only modestly reduced our 2018 adjusted EBITDA forecast to $590 million from $612 million, the company's high financial leverage means that even a small cut to our free cash flow outlook can have an outsize impact on the company's equity value.While management had guided to adjusted EBITDA margins between 8.7% and 9.2%, the company reported only 8.5%. This sits below 10.7% from the same period last year even though market conditions have improved. Volumes were essentially flat versus the first quarter even though management had guided to a 5%-7% increase.
Looking forward to the third quarter, management expects adjusted EBITDA margins to improve by 50 basis points to 9%, which should be achievable assuming no major surprises in terms of outage costs. Even so, AK Steel hasn't yet benefited from the Trump Administration's steel tariff program to the degree that many investors expected they would.
Sharply higher steel prices and lower imports volumes have allowed for more favorable market conditions than the broader U.S. steel industry has experienced in quite some time. Even so, AK Steel's adjusted EBITDA margins through the first half of the year are still only in line with management's midcycle target of 8%. For comparison, our midcycle adjusted EBITDA margin forecast is just above 5%. We are also skeptical that the company will be able to achieve management's 10.5% midcycle return on invested capital target (which is still slightly below our assumed weighted average cost of capital).
AK Steel Holding is a producer of flat-rolled carbon, stainless and electrical steels products primarily for the automotive, infrastructure and manufacturing, and distributors and converters markets through its wholly-owned subsidiary, AK Steel Corporation. The company's other subsidiaries also provide customer solutions with carbon and stainless steel tubing products, solutions, tool design, hot- and cold-stamped steel components and assemblies. The company sells its carbon steel products mainly to customers in North America, and it sells its electrical and stainless steel products primarily in North America and Europe. The company also produces metallurgical coal through its AK Coal Resources, Inc. subsidiary.
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