Citi Initiates Coverage On AK Steel, Sees Nearly 16% Upside

Analyst Alexander Hacking noted that AK Steel has historically struggled to generate FCF, posting negative FCF in every year from 2008–14, despite right sizing their footprint and increasing higher-margin contract business.

"We believe that in addition to lower iron ore input costs and the acquisition of Dearborn Works, the changes that the company has made in its contract mix and operating footprint should help their competitive position and forecast AKS returning to positive FCF over the next several years," Hacking wrote in a note.

In 2015, the company was able to achieve a breakeven cash flow result. In the first half of 2016, AK Steel generated FCF (ex-working capital) of $60 million. The next target will be to reach a position where they are earning their cost of capital.

"While we forecast a significant improvement in ROIC to ~8 percent over the next several years we believe this is still below their WACC which we estimate is closer to 10 percent," Hacking wrote in a note.

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Hacking highlighted it might be more difficult for AK Steel to compete with other producers, especially on spot sales of commodity grade products, as its rivals have cost advantages in the form of different production processes, lower labor costs and captive low cost raw materials.

In addition, the company remains highly levered with $2.0 billion in outstanding debt and $1.2 billion in pension and OPEB obligations versus Citi estimate of 2016 EBITDA of $511 million for a net leverage ratio of 6x.

"This high debt load poses a risk to AKS if economic and industry conditions deteriorate and could limit the ability of AKS to obtain additional financing," Hacking added.

Hacking expects AK Steel to earn $0.38/$0.91/$0.76 for 2016/17/18, respectively. The Street consensus stands at $0.32/$0.57/$0.61.

Shares AK Steel closed Friday's trading at $4.67.

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