Steel Outlook Subdued

This story features BLUESCOPE STEEL LIMITED. For more info SHARE ANALYSIS: BSL

By Chris Shaw

With global steel production still weak GSJB Were has factored in even lower iron ore price contract price estimates, now forecasting annual negotiations to deliver a 40% cut in prices this year against its previous estimate of a 30% decline.

This, when added to its view steel prices generally will bottom out sometime in the current quarter before staging a muted recovery over the balance of 2009, sees the broker trim its earnings estimates for both OneSteel ((OST)) and Bluescope Steel ((BSL)). Despite the changes, the broker has not adjusted its rankings, which sees it class OneSteel as a Buy and Bluescope as a Hold at current share price levels.

For the former the broker acknowledges conditions are currently not so favourable, but for investors with a longer-term timeframe there is value at current levels given significant downside is already priced into the stock. Bluescope poses more of a refinancing risk in the broker’s view while also presenting risks related to a re-lining of a blast furnace in the second half of the year, so while the stock appears cheap there are few obvious catalysts on the agenda.

JP Morgan similarly rates OneSteel as Overweight, having upgraded from a Neutral rating to reflect both greater confidence in its earnings estimates and the fact it sees any equity raising by the company as unlikely given lower working capital requirements will see cash flows improve.

With respect to the weak interim result, JP Morgan has re-examined its numbers and puts much of the poor performance of the mining services segment down to the result of some since eliminated hedging positions and generally poor market timing.

With this largely behind the company, the broker expects OneSteel will enjoy iron ore pricing more in line with industry benchmarks, while it remains of the view management will achieve guidance with respect to targeted iron ore sales volumes.

Following its review the broker makes only minor changes to its earnings estimates and in earnings per share (EPS) terms it expects 39.5c this year and 43.3c in FY10, which puts the stock on attractive P/E (Price to Earnings) ratios of 5.4x and 4.5x respectively. Consensus EPS numbers according to the FNArena database are 36.6c and 33.3c respectively.

The fact an equity raising by the company is unlikely has also been touched upon by UBS, which has attempted to analyse the balance sheet health of both OneSteel and Bluescope by factoring in more negative outcomes than it currently expects.

While UBS suggests the need for an equity raising by either company depends to some extent on their continued ability to match production to reduced demand levels so as to manage working capital efficiently. UBS doesn’t expect either will need to go cap in hand to shareholders as strong cash flows should keep debt at manageable levels.

As an example UBS notes while Bluescope had net debt of around $2.6 billion at the end of 2008 this should be down to $1.8 billion by June this year, while for OneSteel the stockbroker estimates net debt was $2.27 billion in December but this should fall to around $1.74 billion by the end of June.

Even allowing for the more bearish scenarios UBS has envisioned of lower volumes and prices plus higher inventories, the deterioration in the respective financial conditions of the companies, net debt capacities would still not be exceeded, so making capital raisings unlikely in the broker’s view.

UBS rates OneSteel as a Buy and Bluescope as a Hold, while Bank of America-Merrill Lynch has cut its rating on the latter to Underperform from Buy as not only has it cut earnings estimates to reflect weaker steel prices, BA-ML also sees demand as weak enough to make it questionable as to whether or not the company should restart its second blast furnace in coming months.

Overall the FNArena database shows OneSteel is rated as Buy five times, Hold four times and Underperform once, while Bluescope scores two Buys, six Holds and two Sells. Their respective average price targets are $2.89 and $3.17.

Shares in both stocks today are slightly higher despite a weaker overall market and as at 2.00pm OneSteel was up 9c at $2.03 and Bluescope was also 9c higher at $2.44. Their respective ranges over the past year have been $1.63 to $7.88 and $2.09 to $12.29.

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