August 31, 2018

AKS Valens Credit Analysis – CDS 426bps, Base Case iCDS 230bps, Negative Case iCDS 657bps, 2025 6.375% Bond YTW of 7.763%, iYTW of 5.183%, B2 Rating from Moody’s, IG4+ (equivalent to Baa1) Rating from Valens, Low Refinancing Need

  • CDS markets are materially overstating credit risk with a CDS of 426bps relative to an Intrinsic CDS of 230bps, while cash bond markets are grossly overstating AKS’s credit risk with a YTW of 7.763% relative to an Intrinsic YTW of 5.183%. Additionally, Moody’s is materially overstating AKS’s fundamental credit risk, with their highly speculative B2 credit rating seven notches lower than Valens’ IG4+ (Baa1) rating
  • Incentives Dictate Behavior™ analysis highlights mostly positive signals for creditors. Management’s compensation metrics should drive them to focus on all three value drivers: revenue growth, margins, and asset turnover, which should result in Uniform ROA improvement and higher cash flows available for servicing obligations. Moreover, most members of management are not well compensated in a change-in-control scenario, limiting event risk for creditors
  • Earnings Call Forensics™ of the firm’s Q2 2018 earnings call (7/31) highlights that management is confident in their ability to renegotiate rising freight costs. Additionally, management is confident in their ability to compete with Chinese steel companies due to the Trump administration’s protectionist trade policies and that increased pricing will offset underperforming business units
  • AKS currently trades near the low end of historical valuations relative to UAFRS-based (Uniform) Assets, with a 0.7x Uniform P/B (V/A’). At these levels, the market is pricing in expectations for Uniform ROA to remain muted, and improve only from 2% in 2017 to 5% through 2022, accompanied by 2% Uniform Asset shrinkage going forward. Given that valuations are likely being compressed by the market’s inaccurate perception of the firm’s credit risk, AKS could see material credit-driven equity upside if credit spreads tighten, even without fundamental improvement. Moreover, at current levels, equity downside is likely limited, as asset values begin to offer a floor to valuations at these levels
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