AK Steel (NYSE:AKS): Upgraded to Buy at Goldman Sachs

Goldman Sachs is out with a call on Steels recommending Buy AKS/Sell X pair trade in order to mitigate auto sector risks and steel sector risks, while at the same time monetizing their Buy view on AKS and their Sell view on X. Goldman sees three reasons for AKS to outperform X:

1) AKS's variable cost structure and the benefit of lower iron ore prices in 2H2009 vs. fixed costs for X.

2) Earnings could prove a differentiating catalyst; AKS's electrical steel business could surprise to the upside, X's OCTG business to the downside.

3) AKS's balance sheet and covenant restrictions are less worrisome.

AK Steel offers the best upside potential in their coverage universe. Goldman upgrades AKS to Buy from Neutral and raise target price to $12 from $6.50, implying 24% upside. In firm's view, AK Steel's cost structure is much more variable than the market gives it credit, which will see the company benefit from falling iron ore prices in 2H2009. Accordingly, they raise their 2H09 and out year estimates.

The April 21 earnings release could be a positive catalyst for shares as they expect the electrical steel business to remain highly profitable. In addition, AKS will extract better efficiency following extensive repair work at its Middletown furnace. Finally, they are positive onAK Steel's balance sheet as it only has $70 mn of net debt, low leverage, and no maintenance covenant issues.

An AK Steel/US Steel pair trade mitigates risks. Goldman notes their primary concern with their Buy-rated AKS call is the risk of rising counterparty defaults related to bankruptcies in the auto sector. As AKS and X have roughly the same end-market exposure, pairing them helps eliminate this risk. As the two stocks are highly correlated, pairing them may also help eliminate broad sector/commodity risks.

Notablecalls: So, it's basically an AK Steel (AKS) upgrade and one should should treat it as such.

They are not saying anything new re: US Steel (X) - the problems are already well known and shorting based on Goldman's call is basically a market timing call on your part (not the worst of ideas, in my opinion)