Bluescope: Patience Required

This story features BLUESCOPE STEEL LIMITED, and other companies. For more info SHARE ANALYSIS: BSL

By Greg Peel

Steelmaker Bluescope ((BSL)) currently sits in second spot in FNArena's R-Factor rankings with FY11 and FY12 forecast earnings growth of in excess of 100% and 55% respectively and FY11-12 forward PEs of 11.6x and 7.5x respectively (historical average for BSL 11.0x). Forward yields of 4.9% and 7.7% wrap up the package.

Interestingly, Bluescope is pipped only by steel rival slash iron ore producer OneSteel ((OST)). This provides an indication of where analysts see things playing out in the steel industry over the next couple of years.

But in the shorter term, things are not so hot. Yesterday's Bluescope AGM came with revised first half FY11 profit guidance of “break even”, which came as a bit of a surprise to some brokers who had expected a much better result (JP Morgan $72m profit for example) following last year's first half loss. Substantial earnings forecasts cuts have followed, including BA-Merrill Lynch's 109% cut for FY11.

It was a bit of a wake-up call, and for the most part broker's have cut forecasts to below those implied by management's new guidance. Credit Suisse stood out as having no need to reduce forecasts given the analysts had already seen it coming.

Management cited a combination of flat steel prices, ongoing high iron ore and coal costs, soft domestic demand, and a strong Aussie fighting against offshore demand. RBS Australia notes the current steel downturn is into its second year. Past cycles usually last 3-5 years before utilisation rates return to sustainable levels above 80%.

So the outlook does not appear rosy. China is forcing up the price of iron ore but has its own steelmakers to feed its domestic economic surge. In the meantime, JP Morgan notes reports suggest Japan is about to cop a US$30/t price reduction on hot rolled coil sales to Korea from currently pricing of US$680/t. Nor is it helping that Russia/Ukraine is dumping cheap HRC on the market and has its own iron ore sources.

Analysts are split on whether iron ore prices are likely to go up or down from here. China's October trade balance released this week showed a 19% reduction in iron ore imports but Chinese numbers are volatile and inventories are run down and rebuilt seasonally. UBS has upgraded its raw material forecasts for example, but Deutsche Bank is expecting a 22% half on half decline in the iron ore price. Yet Deutsche also expects steel prices to rise 11% when other brokers can't see upside yet.

Either way, there is agreement that one cannot approach investment in BSL on a short term basis. On a longer term basis however, brokers can't get over the fact Bluescope is simply very cheap on every metric and stands to be handsomely rewarded when global economic growth recovers. Whenever that may be.

Bluescope is today trading at $1.98 when RBA estimates the replacement costs of the company's assets equate to $4.85 per share. The Port Kembla facility alone is worth $3.43 according to RBS. At a time when infrastructure costs are rising, replacement value is all important and leads to takeover potential.

Mind you, that's also been the Alumina Ltd ((AWC)) story since time immemorial.

All brokers agree that the patient investor should be rewarded for sticking by Bluescope. Best one just shoves the scrip in some bottom drawer and forgets about it. It will be a rocky road, but seven out of eight FNArena database brokers have a Buy on the stock. Fortunately Merrills' Neutral saves BSL from the dreaded 100% Buy rating which so often is the kiss of death.

The consensus target has been trimmed down to $2.89 but that still suggests 45% upside.

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