Billionaires Betting On Small Steel: AK Steel (AKS) Versus United States Steel (X)

What’s the best way to play a potential turnaround in the steel industry? Well it’s not the company you would think. United States Steel Corporation (NYSE:X) is considered the bellwether of the steel industry, but we believe AK Steel Holding Corporation (NYSE:AKS) is the best bet in this space. Cliff Asness of AQR Capital also thinks so and is the top fund owner of AK Steel – owning 4.3% of the steel company. AQR upped its stake over 60% last quarter, along with other notable billionaires, including Ken Griffin, Steve Cohen and Israel Englander (check out Israel Englander’s newest picks).

Steel volumes are expected to be up in 2013 on the back of rising U.S. GDP and robust auto sales. Further helping boost the industry should be bullish demand from the construction industry, as a turnaround in real estate gains traction. Standard & Poor’s expects steel consumption to be up 7% in 2013, and also anticipates an increase in auto sales in 2013 to 15.4 million units, from 14.4 million units projected in 2012.

We believe that other top competitors just do not have the same prospects that AK presents, including US Steel, Steel Dynamics, Inc. (NASDAQ:STLD), Ternium S.A. (NYSE:TX) and ArcelorMittal (NYSE:MT).

US Steel has the lowest expected EPS growth rate of the five steel stocks with a 7% CAGR and its valuation is less than stellar at 15x forward earnings – in line with its historical P/E. The steel company does have more international exposure than AK Steel, but we do not like its tubular-related products exposure. Almost 20% of revenues for the first nine months of 2012 were in its tubular segment, which has vast exposure to the oil and gas markets. As a result, US Steel is more dependent on the number of oil and gas wells drilled, and can easily see demand impacted by new drilling and storage techniques. AK Steel only derived 2% of its revenues from tubular over the same period. Billionaire Jim Simons was one manager betting on US Steel in 3Q 2012 (check out Jim Simons’ top picks).

AK has seen the same pressures, if not more, as other steel companies: The S&P Steel Index was down 11% through mid-December 2012, where the S&P 1500 was up 13%, but AK Steel was down almost 50%. Over the last five years, the steel stock is down 90% and has seen earnings decline at a 50% compounded annual growth rate over that same period.

With all the negative pressure and poor historical performance, why invest?