Australia | Nov 20 2007
By Chris Shaw
Usually a downgrade in earnings guidance is enough to see brokers pare back optimistic views on a company but this has not happened in the case of Australian steel player OneSteel ((OST)), as even after a revision to earnings yesterday analysts are still positive on the stock.
Management yesterday announced revised EBITDA (earnings before interest, tax, depreciation and amortisation) guidance for FY08 of between $710-$780m, which compared to a market consensus prior to the AGM of $700-$850m. As an example, JP Morgan had been forecasting $802m for the year while Merrill Lynch was at $840m.
The reason brokers remain positive on the company’s outlook is the expectations of an earnings bounce in the second half of the fiscal year, as JP Morgan points out weaker margins from an overhang of import volumes in the current half are showing some signs of easing and synergies from the recent merger with Smorgon Steel should come in well above previous expectations.
UBS agrees with the view synergies should exceed expectations, while also expecting the second half to show an improvement as it notes the current inflow of lower priced imports is preventing the company from lifting prices and so offsetting higher raw material costs.
The other area of upside in the broker’s view is the company’s iron ore operations, where the company is well placed as not only can it supply its own needs but it is expected to be able to sell additional iron ore at a time when prices are soaring.
The initial target is sales of four million tonnes annually, but this is expected to increase to as much as 10 million tonnes in coming years. Merrill Lynch also sees some potential for upside to earnings from the iron ore operations, suggesting the risks associated with Project Magnet have actually reduced as the company appears to now be happy with the pellet quality being produced.
In addition the broker sees some growth opportunities as the Smorgon acquisition is fully integrated into the company, so it too sees no reason to shift from its Buy rating despite the cuts to forecasts.
It agrees with the likelihood of earnings in the second half being far stronger than the current half year, as on the broker’s numbers the company should record a net profit split of $114 million this half and $184 million in the second half.
In terms of actual earnings adjustments, brokers have cut forecasts by as much as 6% in FY08, but the outlook remains one of solid earnings growth as in EPS (earnings per share) terms the company should be increasing its earnings from around 40c this year to more than 50c in FY09.
Overall the FNArena database shows OneSteel is rated as Buy seven times, Hold twice and Underperform once, Citi upgrading to Buy this morning on valuation grounds after recent share price weakness. JP Morgan’s Buy call is also value related as it notes the stock is one of the few currently trading below its DCF valuation, which it estimates to be $6.45.
Shares in OneSteel today are slightly weaker and as at 1.40pm were down 9c at $6.27. This compares to an average price target according to the FNArena database of $7.18 and a median price target of $6.75 according to Thomson One Analytics.