Could Lower Spot Exposure Improve AK Steel’s Profitability?



Lower spot exposure

As we discussed in the previous part, AK Steel (AKS) and U.S. Steel (X) have cut their spot sales while Nucor (NUE) has increased its exposure to the spot flat-rolled sheet products. Now let’s explore how lower spot exposure will affect AK Steel.

Could Lower Spot Exposure Improve AK Steel's Profitability?

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Profitability per ton

Spot sales are generally less profitable for steel companies. By having a higher share of value-add products in its portfolio, AK Steel (AKS) can improve its per ton profitability. Also, contact sales are typically less volatile in terms of pricing as compared to spot sales.

However, AK Steel can’t be immune from volatility in spot steel prices. The graph above shows the trend in AK Steel’s per-ton EBITDA (earnings before interest, taxes, depreciation, and amortization). As you can see, its per-ton EBITDA has fallen in 1Q16 despite lower spot exposure. This is because a lot of automotive contracts got rolled over at the beginning of the year when spot steel prices were quite depressed. However, as some of these contracts get reset throughout the year, we could see the positive impact on AK Steel’s earnings.

Automotive exposure

The truth is that high automotive exposure is actually a double edged sword. The automotive market is among the most lucrative end markets for steelmakers. But getting a disproportionate share of revenues from one market brings concentration risk for AK Steel. Although auto sales have been growing at a decent pace so far in 2016, any slowdown in vehicle sales could turn the heat on AK Steel.

On a macro level, steel is facing a challenge from aluminum. Some automakers including Ford (F) have increased aluminum content in vehicles. Meanwhile, although rising aluminum intensity in vehicles is a long-term headwind for AK Steel, the company faces a near-term challenge in higher raw material prices. (We’ll discuss this more in the next part of the series.)

You can also consider the Materials Select Sector SPDR ETF (XLB) to get diversified exposure to the materials sector. Metal producers currently make up ~11% of XLB’s portfolio.

Now let’s analyze AK Steel’s profit margin.


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