AK Steel Still Has Room for Upside

By all accounts, AK Steel's first quarter was lackluster. Winter weather lifted costs and brought shipment problems.An unplanned outage at the company's Ashland Works blast furnace added to costs. As a result, the company scored a net loss of $86.1 million and swung to negative operating cash flow. Last year, the shares of AK Steel were among the best performers, but this year, they struggled to get back into positive territory. However, as summer wipes of AK Steel's weather-related problems, its shares could find firmer ground.

Low raw materials prices help costs
The main ingredients of steelmaking, met coal and iron ore, remain at extremely low price levels. What's more, there are few signs this situation will change in the near term, especially for iron ore. AK Steel will satisfy half of its needs for iron ore when its Magnetation plant will be at full production in 2015, but the rest of the ore will have to be bought from third parties. In the current environment of falling iron ore prices, this is an advantage rather than a disadvantage.

In comparison, U.S. Steel relies heavily on its own iron ore, except for its European facilities. Thus, U.S. Steel does not benefit from falling iron ore prices, however, it enjoys the downside in the met coal market, just like other steelmakers. The big problem is that steel prices are under pressure as well. Besides other problems, the steel industry is suffering from a flood of cheap imports. The industry seeks government action over what it believes is unfair competition, but not much progress has been made on this front so far.

Pressure from aluminum producers is overrated
The enthusiasm over the use of aluminum in the auto production has kept shares of Alcoa rising this year. However, in Alcoa's case, investors are betting on the future size of aluminum invasion into traditional steel territory. Whether optimistic projections will turn into reality remains a question, but in the shorter term, Alcoa and other aluminum producers are not a big threat to steelmakers' profitability.

Just like other steel producers, AK Steel works to increase the share of its value-add business in the revenue mix. The automotive market accounted for 51% of the company's sales last year, and the growth of its share in the revenue mix is going to continue. AK Steel stated that it expected solid demand from automotive customers to continue this year. At the same time, the electrical steel segment remains under pressure from imports and excessive global capacity, so the performance of the automotive segment is crucial for the company.

It's understandable that the growth of aluminum usage worries steel investors, as the industry is in a fragile state. However, the industry as a whole, and AK Steel in particular, have the time to prepare their response with new steel solutions for automotive production.

Bottom line
While the first quarter was bleak, the company is expected to return to profitability in the second quarter. Meanwhile, AK Steel's shares continue to trade at a significant discount to peers if judged by forward P/E, which leaves room for upside.

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The article AK Steel Still Has Room for Upside originally appeared on Fool.com.

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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