This Steel Stock Is a Courageous Buy

This Steel Stock Is a Courageous Buy

AK Steel is having a tough year. The company is struggling to become profitable, which is a task that has not been achieved in 2013. AK Steel's recent earnings report showed that its third-quarter loss narrowed to $31.7 million from $40.4 million in the second quarter. However, the company is not out of the woods yet and is expected to post a loss at year-end. On the other hand, the stock that once traded above $60 is selling for just $4.

Minuscule steel price improvements
AK Steel continues to suffer from low steel prices. The company sold its steel for an average $1,071 per ton, a slight improvement from $1,061 per ton in the second quarter. Clearly, this is not enough empower the business. Although AK Steel managed to post an operating profit, interest expense of $32 million combined with a $12 million loss from an unplanned outage on its Middletown blast furnace led to a net loss.

As another steelmaker, Nucor , stated during its earnings call, cheap imports from China put enormous pressure on the U.S. steel market. Imports of steel to the U.S. are on pace to exceed 30 million tons, double the 2009 level. China is estimated to have 300 million of excess steel capacity. As nothing material is done to deal with this problem, steel prices are expected to remain where they are.

Nucor has been performing reasonably well, as its stock is up 20% year-to-date. On the other hand, Nucor expects its fourth-quarter earnings to be lower than its third-quarter earnings, so there's little upside left for the stock.

A pile of debt
AK Steel has $1.45 billion of debt to deal with. At the end of the third quarter, the company had just $66 million of cash remaining on its balance sheet. Luckily, AK Steel has $760 million in available credit facility, so there would be no liquidity crunch for the steelmaker.

Steel Dynamics has a comparable amount of sales and debt, but the capitalization of these two companies differs very much. The market values Steel Dynamics at $4 billion, while AK Steel is valued at $0.55 billion. The reason is simple: Steel Dynamics is making money, while AK Steel is losing them.

The company recently reported a 6% rise in sales from the second quarter and a 64% rise in operating income. However, the steel market environment is the same for all its participants, so I'm skeptical about the further growth of the company.

What's in the future?
AK Steel is a beaten-down steelmaker and could present value should the company finally become profitable. Is it possible? I think so. The company is shifting away from spot pricing to contract pricing. Spot pricing is volatile and sometimes unpredictable, while contract pricing is fixed. The company has already reached a level when 75% of its steel is sold on contracts.

Another opportunity is to sell more steel to the automotive industry, which is performing well. The other product that AK Steel has, electrical steel, is under significant pressure from imports. As no miracles are awaited on this front, the company should try to migrate to more value-add production.

So, what's the bottom line? AK Steel is a very risky buy. The upside potential is big if the prices tick up a little and the company returns to profitability. At the same time, the downside risk is substantial too. Should steel prices go lower, AK Steel will struggle to make ends meet.

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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