AK Steel to Test Its "Mittal"

We expect AK Steel Holdings' (AKS - Analyst Report) cost reduction efforts and renegotiated higher-priced contracts to prevent excessive margin deterioration in light of higher commodity costs. The company has greater product diversification compared to its peers and is focusing on markets and products which have the greatest long-term potential for success.

We believe the company will gain from new projects, higher selling prices, and increased shipment. Hence, we reiterate the Buy rating and raise our six-month target price to $69.00. This is 14.1x our 2008 EPS estimate.

The continued cost containment strategy and reduction of legacy costs has made AK Steel an attractive takeover target. Arcelor Mittal (MT - Snapshot Report) intends to take it over and is contemplating a $40 per share bid. However, the management has not commented about this transaction at present.

AK Steel has implemented surcharges on flat-rolled carbon and electrical steel products in response to higher raw material and natural gas costs. Moreover, based on strong demand for steel, it expects a double-digit increase in the new contract prices of oriented electrical steel products.

AK Steel has negotiated 12 new-era competitive labor agreements in the last three years and is focusing on cost containment through workforce reductions. Meanwhile, AK Steel redeemed the entire $450 million of 7.9% senior notes due in 2009 in about a six-month period. This has reduced an annualized interest expense by approximately $70 million.

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