Produce Over 9.5% YTM with AK Steel, Bonds Maturing October 2025

  • A 36% increase in adjusted EBITDA over first quarter 2018.
  • Sales of $1.7 million, representing a 2% year-over-year increase.
  • Adjusted net income up over 150% (excluding a one-time charge).
  • Interest coverage of 2.4x.

This week, Durig Capital looks at one of the leading producers of steel products in the United States. AK Steel has been working diligently over the past few years to increase its competitiveness in the marketplace. Its design of its own ultra high-strength steel (UHSS) has produced excitement amongst the company’s automotive customer base. In addition, AK Steel’s acquisition of Precision Partners a few years ago has been very lucrative as that acquisition has now resulted in approximately $50 million in additional future revenues. The company recently released its first quarter results for 2019. Amongst some of the highlights:

AK Steel surprised analysts in this most recent quarter, beating earnings expectations by almost double ($0.23 earnings per share versus expected $0.12 earnings per share). This is the second consecutive quarter of beating analysts EPS estimates, and while the stock still appears to be value priced, AK Steel’s 2025 bonds are also trading at a discount at the moment. This means the yield-to-maturity is very competitive at about 9.75%. For investors looking for additional diversification as well as an outstanding yield, this could be the answer. In light of AK Steel’s most recent performance, these bonds look to be an excellent addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.

 

 

First Quarter 2019 Results

AK Steel’s growth strategy consists of three elements: commercialize innovative new products and services, transform its operations to improve its competitive position, and drive future growth, both organically and through acquisitions, into new markets and downstream businesses. The company’s first quarter results show progress towards these initiatives. Roger Newport, AK Steel’s CEO, commented on the company’s most recent results. “These results demonstrate that our strategy is indeed working well and that we are delivering on our commitment to continually improve the performance of our company.” Highlights from AK Steel’s first quarter include:

  • First quarter Adjusted EBITDA was $160.9 million, an increase of 36% year-over-year.
  • Adjusted EBITDA margin was 9.5% in the first quarter, an improvement from 7.2% a year ago.
  • Sales of $1.7 million, a 2% increase from the first quarter of 2018.
  • Adjusted net income increased by over 150% to $72.9 million in the first quarter, excluding a one-time closure charge of $77.4 million for the company’s Ashland Works facility.

Perhaps one of the most exciting developments for AK Steel is the increased use of ultra high-strength steel, primarily in the automotive industry. The company has spent the past few years investing in and developing these advanced materials.

About AK Steel

AK Steel is a leading producer of flat-rolled carbon, stainless and electrical steel products, primarily for the automotive, infrastructure and manufacturing, including electrical power, and distributors and converters markets.  Through its subsidiaries, the company also provides customer solutions with carbon and stainless steel tubing products, die design and tooling, and hot- and cold-stamped components.  Headquartered in West Chester, Ohio (Greater Cincinnati), the company has approximately 9,500 employees at manufacturing operations in the United States, Canada and Mexico, and facilities in Western Europe. AK Steel is a publicly held company traded over the New York Stock Exchange under the symbol AKS and is a component of the FORTUNE 500 – aligning the company with many of the most prominent corporations in America.

Growth in the Use of Ultra High-Strength Steels

High strength steel is a very valuable commodity in the automotive market. As automakers continue to strive to create efficiencies in their vehicles, making the vehicle lighter is almost always a goal when focusing on fuel efficiencies. Consider this – today’s vehicles contain, on average, about 75 pounds of ultra high-strength steel (UHSS). By 2025, that amount is estimated to grow to 320 pounds, an increase of more than four times its current amount. How much does the use of UHSS reduce the weight of automotive components? When heavy steel is replaced by UHSS in automotive components, the weight decreases by 10% to 60% depending on the particular component. This is a significant weight savings which contributes to additional fuel efficiencies. In light of this, auto manufacturers are eager to add additional UHSS components to their vehicle designs. In fact, the use of UHSS is estimated to grow at an CAGR of 24% between now and 2025.

(Source: AK Steel April 2019 Investor Presentation)

Since AK Steel has a vast majority (70+ percent) of its business derived from the automotive sector, it has spent significant time, money and energy developing its family of ultra high-strength steel – NEXMET 1000 and NEXMET 1200. AK Steel’s research and innovation group has been working in conjunction with its teams at Precision Partners to demonstrate the full breadth of its steel solutions it now offers to its customers.

Growth from Precision Partners

In 2017, AK Steel acquired Canadian-based, Precision Partners, one of the leading North American providers of complex, highly engineered automotive tooling and hot & cold stamped solutions. Founded in 1955, Precision Partners is a critical supply chain partner in the automotive market. Since that time, Precision Partners has formed a productive partnership with AK Steel. This partnership has been so productive that the company is building a new facility to support the business that has been awarded to Precision Partners.  These new business awards represent approximately $50 million of annual revenue for AK Steel.

Interest Coverage and Liquidity

It’s important for an issuer to have both adequate interest coverage as well as liquidity. At first glance, AK Steel has adequate interest coverage, with operating income at $41.2 million and interest expense of $37.9 million, resulting in an interest coverage ratio of just over 1x. However, calculating operating income without the effect of non-cash depreciation of $50.4 million, results in operating income for the first quarter of $91.6 million. This results in an interest coverage ratio of 2.4x.  In terms of liquidity, AK Steel has more than adequate liquidity of $937.5 million (as of March 31, 2019) made up of cash and the company’s revolving credit facility. Part of the reason for such high liquidity is that the company is considering using the available room on its revolver to pay down $149 million of convertible notes that mature later this year.

Risks

The risk for bondholders is whether AK Steel can effectively accomplish its strategy of growth. The company made a smart investment in Precision Partners two years ago and that investment appears to be paying off. It is making smart decisions to consolidate its operations. With the closure of the Ashland Works facility, the company expects to realize $40 million of annual run rate savings beginning next year. And AK Steel’s investment into formulating its own ultra high-strength steel has made it one of the go-to suppliers for this in-demand material for the automotive industry. In light of these accomplishments, the excellent yield-to-maturity of about 9.75% on the company’s 2025 bonds does appear to outweigh the risks identified.

In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments.  Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.

 

 

Summary and Conclusion

Federal fuel economy standards for newly manufactured automobiles continue to increase. In order to comply with these standards, automakers are continuing to introduce new models that are lighter and therefore more fuel efficient. A key to reducing the weight of the vehicle is the material used to make the car. With its light, but strong, ultra high-strength steel products, AK Steel looks perfectly positioned to take advantage of this situation. Its acquisition of Precision Partners two years ago has brought in enough business for the company to warrant an entire new facility to accommodate the extra business Precision has been able to secure. AK Steel’s 2025 bonds, couponed at 6.375%, provide investors the opportunity to diversify indirectly into the auto sector. As these bonds are currently trading at a discount, the yield-to-maturity on these shorter-term bonds is an outstanding 9.75%, making these competitive yielding notes make an ideal addition to Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.

Issuer: AK Steel Corp.
Ticker: NYSE: AKS
Coupon: 6.375%
Maturity: 10/15/2025
Ratings: B3 / B-
Pays: Semi-annually
Price: 84.10
Yield to Maturity: ~9.75%

 

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Disclosure: Durig Capital and certain clients may hold positions in AK Steel’s October 2025 bonds.

Disclaimer: Please note that all yield and price indications are shown from the time of our research.  Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. The high yield strategies presented in this review by Durig Capital may not be suitable for all investors.  This is not investment advice from Durig Capital, nor a specific recommendation to buy or sell securities. If you have any questions or concerns about its suitability for your personal investment, you should seek specific investment advice from a registered professional before making an investment decision.

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