TEXT-S&P cuts AK Steel Holding Corp to 'B+'

Fri Jun 29, 2012 9:51am EDT

June 29 - Overview

-- Industry conditions remain difficult for steel sheet producers as excess capacity and imports pressure prices, raw material prices remain high, and demand has been uneven.

-- Operating results at AK Steel Holding Corp. have been weak, and we do not expect credit metrics to recover to levels consistent with the rating during the next several quarters because of the company's high fixed costs and weaker-than-expected prices.

-- We are lowering our ratings, including the corporate credit rating, on West Chester, Ohio-based steel producer AK Steel to 'B+' from 'BB-'.

-- The stable outlook reflects our expectation that the company's operating performance will gradually improve along with the economy, resulting in credit metrics consistent with a 'B+' rating by the end of 2013. Rating Action On June 29, 2012, Standard & Poor's Ratings Services lowered its ratings, including the corporate credit rating, on AK Steel Holding Corp. to 'B+' from 'BB-'. The rating outlook is stable. Rationale The downgrade reflects our assessment that AK Steel will continue to have weak financial metrics stemming from continuing difficult competitive conditions, including uneven demand, excess capacity, declining prices, and relatively high raw material costs. We are also concerned that weaker markets globally, mainly a result of eurozone uncertainties and slowing growth in China, will limit the growth in the U.S. economy and weigh on pricing in the steel markets. Given the relatively fixed cost nature of the company's business, we expect that lower prices will keep margins low and result in weak operating performance. We expect 2012 EBITDA--although better than last year--to be below $300 million and debt to EBITDA to be above 8x. We also expect funds from operations (FFO) to total debt to be below 10%. This is well below our previous expectations of between $350 million and $400 million of EBITDA and debt to EBITDA of about 6x (adjusted for post retirement benefit obligations, operating leases, and asset retirement obligations). Moreover, our expectations for 2013 are now less optimistic, with demand remaining sluggish, although we still expect improvement over 2012. Based on our expectations, which include moderating raw material costs and continuing slow economic growth in the U.S. that results in modest pricing and volume gains, debt to EBITDA should decline but remain above 6x in 2013, but approaching levels that, in our view, are more appropriate for a 'B+' rating. For the rating, we expect total adjusted debt to EBITDA of about 5x and FFO to total adjusted debt of 15% to 20%. The corporate credit rating and outlook reflect the combination of the company's "fair" business risk profile and "aggressive" financial risk profile. The ratings also reflect its good market positions in a number of value-added steel products and its "strong" liquidity. Its relatively small size, high fixed costs as an integrated steelmaker, lack of backward integration, limited diversity with high exposure to the automotive market, significant legacy costs, and weak credit metrics somewhat offset the strengths. Although AK Steel has become somewhat more cost-competitive compared with its peers and has taken steps to reduce its other postretirement employee benefit (OPEB) liabilities, we believe it remains disadvantaged because of its lack of backward integration. The company is exposed to higher procurement costs because it doesn't own or control any iron ore or metallurgical coal (met coal) assets. High iron ore and met coal prices, which have increased significantly since 2009, have been a drag on operating performance during the past few years. The company has recently made two acquisitions to address a portion of its raw material needs, but we do not expect them to affect financial performance for several years. AK Steel manufactures flat-rolled carbon, and stainless and electrical steel, which compete in cyclical and capital-intensive markets. The company has a somewhat higher value-added product mix than many of its peers, with less than 20% of shipments coming from commodity steel products. Still, it has limited diversity. Sales to the automotive industry account for more than 35%. Liquidity In our view, AK Steel's liquidity is "strong" based on our liquidity criteria. Relevant aspects of our assessment of the company's liquidity profile include:

-- We expect that sources of liquidity over the next 12 months will exceed uses by 1.5x or more and believe that sources would exceed uses even if EBITDA were to decline by 30%.

-- We believe that AK Steel has sufficient covenant headroom under its credit facility such that a 30% decline in EBITDA would not result in a breach of financial covenants.

-- The company has no meaningful debt maturities until 2020. As of March 31, 2012, AK Steel had total liquidity of approximately $883 million, consisting of $42 million in cash on hand and about $840 million available (net ofabout $81 million in letters of credit) under its $1.1 billion revolving credit facility due 2016. This facility requires the company to maintain a minimum fixed-charge coverage ratio of 1x if availability under the facility is less than $137.5 million. We do not expect availability to fall to this level during the next several quarters, given our operating assumptions. In our view, the company is likely to post negative cash flow in both 2012 and 2013. Expenditures likely will include capital spending of about $100 million, annual pension and OPEB funding requirements of about $200 million in 2012 and $300 million in 2013 (this could be less if currently proposed pension funding legislation is passed), and a $22 million dividend. We do not expect the company to aggressively pursue share repurchases given the current operating environment. Recovery analysis For the complete recovery analysis, see the recovery report on AK Steel Holding Corp. to be published shortly after this report on RatingsDirect. Outlook The outlook is stable, reflecting our expectation that the company's strong liquidity will support its operations through this weak period. The company's results will likely slowly improve along with the economy, in our view, as pricing improves modestly and raw material costs moderate. Still, we expect credit measures to remain elevated during the next year or so, with adjusted debt to EBITDA between 6x and 7x by the end of 2013 and FFO to debt of about 10%. We could lower the corporate credit rating further if industry conditions and AK Steel's financial performance during the next several quarters are weaker than we expect and liquidity deteriorates. We would consider a downgrade if EBITDA continues to be below $300 million, debt to EBITDA remains above 6x, and total liquidity (cash and availability on its revolver) falls below $300 million. We could raise the rating if markets and pricing markedly improve and we believe the company will be able to strengthen and maintain its adjusted leverage at or below 5x. This could happen if the U.S. economy grows faster than we expect, leading to a resurgence in construction that raises steel prices and causes the company's EBITDA to exceed $400 million. We may also consider raising the rating if the company is able to realize sustainably lower costs and higher EBITDA through its investment in iron ore and met coal. Related Criteria And Research

-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

-- Key Credit Factors: Methodology And Assumptions On Risks In The Metals Industry, June 22, 2009

-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009

-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Downgraded; Outlook Action

To From AK Steel Holding Corp. Corporate Credit Rating B+/Stable/-- BB-/Negative/-- AK Steel Corp. Corporate Credit Rating B+/Stable/-- BB-/Negative/-- Downgraded

To From AK Steel Corp. Senior Unsecured B+ BB-

Recovery Rating 3 3 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.

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