Charles Mead and Sonja Elmquist report:
AK Steel Holding Co. is relying on its $1.1 billion revolving credit facility to cover the industry’s deepest cash burn as the most leveraged U.S. steelmaker bets on raw-material investments to restore profit.
AK Steel borrowed $40 million from its previously untapped credit line in the second quarter as its cash balance fell 74 percent from the end of last year, according to data compiled by Bloomberg. The West Chester-based company burned through $126 million in the last year, a rate that would exhaust the remaining $58.4 million of cash in less than six months.
While the company is selling more material to U.S. automakers, it’s still struggling to contend with a global supply glut and is draining cash to fund projects including an iron-mining venture. That’s left its $550 million of 7.625 percent bonds due May 2020 trading at 86.5 cents on the dollar to yield 10.45 percent Monday in New York, the highest of any similar-maturity note in the metals and mining industry.
“That’s their hope, that earnings improve to where they can pay operating expenses without having to draw down on their revolver,” Wen Li, an analyst at debt researcher CreditSights Inc. in New York, said in a telephone interview. “But that’s proven an issue for them over the past few years, where they’ll fund operations using the revolver and then come to market and issue debt or equity to pay down the revolver — that’s not sustainable going forward.”
AK Steel raised about $600 million in debt and equity in November to help pay down the credit line, which matures in April 2016, and last month added $30 million to the $350 million of 8.75 percent senior secured notes it sold eight months ago. With a revolving loan, money that’s been paid back can be borrowed again.
The company said in a July 23 statement that it had $905.3 million of available liquidity, which includes its cash and remaining revolver capacity, a 14 percent decline from the previous quarter.
While “our liquidity currently is in excellent shape,” Chief Executive Officer James Wainscott said during a conference call to discuss second-quarter results with analysts and investors last week, “we know we’ve got to get back to cash generation.”
AK Steel has been burning through cash for the past five years and may continue to do so into 2015, according to Kip Penniman at KDP Investment Advisors Inc., who wrote in a July 23 report that the “large revolver should provide adequate financial flexibility in most scenarios.” Penniman forecasts total liquidity to decline below $600 million next year.
Mike Wallner, a spokesman at the company, said in an e-mail that “we are always assessing the capital needs of our business and we take the necessary actions at the appropriate times that fit with our long-term strategy.”
AK Steel is among domestic producers of the metal including U.S. Steel Corp. that slashed production capacity after the collapse of Lehman Brothers Holdings Inc. in 2008. Just as the industry began to recover in 2010, global demand waned and economic growth slowed in China, the biggest consumer of the metal, which sparked a surge in imports to the U.S. that’s depressed prices.
“It’s been five long tough years of slugging it out,” Wainscott said on the conference call.
AK Steel’s 7.625 percent notes, which the company issued in April 2010 to yield 486 basis points more than similar-maturity Treasuries, pay a spread of 787 basis points, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. A basis point is 0.01 percentage point.
“It’s clearly a more speculative, higher-risk type of bet,” Evan Mann, a debt analyst at Gimme Credit LLC who rates AK Steel bonds “outperform,” said in a telephone interview. “But you’re being paid handsomely for the risk you’re taking.”
The securities, rated B3 at Moody’s Investors Service, now yield about 3.6 percentage points more than U.S. Steel’s $600 million of 7.375 percent bonds due April 2020, which are ranked two levels higher at B1. That compares with an average spread of about 3.1 percentage points over the past year.
Generating free cash, which analysts surveyed by Bloomberg don’t expect to occur at least through 2014, would provide AK Steel with funds it could use to pay down debt that’s surged to $1.46 billion, the highest level in more than a decade. Free cash can also be used to reinvest in the business or to reward shareholders through dividends and buybacks.
The steelmaker expects to stem losses in part by saving an annual $200 million by 2015 linked to its $36 million purchase of Solar Fuel Co. to mine its own metallurgical coal and the formation of a joint venture with Nashwauk, Minnesota-based Magnetation Inc. to produce about 400,000 metric tons of iron- ore concentrate a year.
“AK has essentially integrated backwards into the raw materials with the view that raw material prices are likely to stay high,” Brian Yu, a San Francisco-based analyst with Citigroup Inc., said in a telephone interview. “If they can produce it for cheaper than they can buy it for, it’s worth the capital investment.”
That strategy requires AK Steel to maintain spending even as profitability has deteriorated. By continuing to invest in the business and using the revolver to cover cash deficits, the company is signaling it expects operations to rebound before its funding sources are exhausted.
“They’re basically betting that they put enough liquidity in place that they can ride out the storm,” Mann said. “And then as soon as the situation turns around, they’ll be a free- cash flow generator and they can pay down all that debt that they took on.”