A Stronger Second-Half for this Steel Company?
The S&P 500's third-worst performing group for the first half of the year, materials are down 7.7% and AK Steel Holding, a stock Cramer has disliked in the past, is down 37% year to date.
Cramer recommended investors avoid AK Steel on April 22, when it was trading at $18.92. He didn't like the stock because it's not a vertically-integrated steel maker, meaning it needs to buy its primary raw materials because it doesn't have its own mines. At the time, prices were increasing and those who listened to Cramer sidestepped a 29% decline in the stock. He also hasn't liked the company because it mainly serves the domestic markets instead of the international ones.
"America is the caboose, not the engine of global economic growth," Cramer said. "I've been wary of the company's balance sheet, one that's burdened by excessive legacy costs."
Cramer now thinks AK Steel could be poised for a turnaround, but he doesn't think it will impress when it reports on July 27. He does, however, think the company will have a "much better" second half and healthy 2011, which means investors can buy some now and more on weakness after the quarter.
So why did Cramer change his mind on AK Steel? After slamming the company, he took another look. Since new management took over in fall 2003, he said, the company has been reinventing itself. In doing so, the company reduced its employee headcount by 30% while maintaining the same production capacity of 6.5 million tons. The aforementioned legacy costs have come down, too, from $40 per ton in 2003 to $7 a ton in 2009, as noted by Goldman Sachs in its upgrade of the stock earlier this week.
AK Steel has used more than $2 billion of internally generated cash to shore up its balance sheet, Cramer said. It has managed to muddle through the recession without selling equity, issuing debt or cutting its small dividend, which has a 1.5% yield.
As mentioned, Cramer did not like AK because it was less vertically integrated than its competitors. That meant it was more vulnerable to increases in iron ore prices and spot prices for iron ore rose 55% between January and mid-April. But since then, iron ore has plummeted and contract prices are expected to be low in the coming quarters. As a result, Cramer said its steel margins should start improving if not this next quarter, then by the fourth.
"Right now steel's in glut mode and all of the steel stocks are crumbling, but that won't last forever," Cramer said. "As the rest of the world's economies rebound, steel prices should rise along with utilization rates at the steelmakers, both major positives for AK Steel."
Cramer thinks the market is pricing in bearish sentiment more than it's reflecting lower costs and how the world's economies are stronger than most believe. That doesn't, however, mean AK Steel's earnings report will impress. But with the stock down 37% and the short interest up at 14%, Cramer thinks a strong second-half is in the works.
"Remember, though, that this one is speculative," Cramer said. "You should take your time and buy it on weakness."
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