Price Volatility Strikes BlueScope

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

-Domestic steel benefit from AUD
-NZ iron sands estimates reduced
-Global steel prices deteriorating
 

By Eva Brocklehurst

BlueScope Steel ((BSL)) delivered a strong first half performance but this was overshadowed by a more subdued outlook for the second half. Underlying improvements in the first half were on the back of a weaker Australian dollar, better domestic sales mix and more favourable steel spreads. However, momentum in global steel pricing has turned negative.

Nevertheless, Morgan Stanley considers the lags embedded in the business should buffer the earnings profile in the second half. The broker acknowledges that a rebound in steel prices after Chinese New Year is required in order to deliver upside risk to guidance. The domestic steel business continues to recover as it benefits from a lower Australian dollar and higher domestic prices. Second half guidance appeared weak, with the main reason being regional steel prices which are hampering domestic profitability.

Morgan Stanley suspects buyers may be holding back and, should the post Chinese New Year rebound occur, along with further Australian dollar weakness, then guidance would become conservative. On this note, the broker also points to the company’s track record of beating guidance.

UBS is disappointed in the second half guidance. Other markets are also weakening, with the broker materially reducing New Zealand iron sands estimates. BlueScope’s NZ iron sand business is operating at only break-even at spot iron ore prices. The broker remains attracted to the stock, despite having to re-base expectations to incorporate a worsening global steel price environment, particularly vis-a-vis China and Thailand, over the next 18 months. Still, earnings are strengthening, driven by higher volumes in most markets. Moreover, the company has resumed its dividend payments and free cash flow should improve as investment activity rolls off.

Steel price deterioration has been driven by an oversupply of product and Chinese exports. This is exacerbated by the higher US dollar. The near-term outlook is likely to remain challenging until supply is better aligned with demand, or there are measures to curb the amount of product exports from China. Credit Suisse, too, considers the earnings spread in steel is highly unfavourable and likely to remain so until low-cost Chinese and Russian steel exports abate. That said, the company’s results reveal favourable metrics compared to global peers which have greater oil industry exposure and higher debt. 

Credit Suisse was pleasantly surprised by the 3c interim dividend, which suggests management is confident in the outlook and cash flow. Forward indicators suggest that domestic tonnage and product mix should move to a sweet spot, as soon as detached dwelling and renovation work comes through, although the broker concedes this recovery remains elusive at present. Meanwhile, US businesses are leveraging stronger activity and favourable spreads for the North Star business.

The company’s inability to achieve a domestic premium in a falling price environment is probably why second half guidance was downgraded, in Deutsche Bank’s view. The company has guided to earnings growth of 20% in the second half which implies a downgrade to FY15 consensus expectations. To achieve its target the broker believes steel prices would need to increase and the AUD/USD remain flat.

Short-term volatility should not stand in the way of long-term value, Citi contends. NZ iron sands felt the impact of the fall in the iron ore price but the broker points out this iron ore weakness is of benefit to the company’s manufactured product. Hence, while steel prices are a function of iron ore price forecasts and this will weigh on iron sands, the broker includes in estimates the beneficial impact of increased long steel product despatches from Pacific Steel, which helps mitigate the negatives.

There are both strengths and weaknesses in BlueScope’s business, which keeps Morgans in a holding pattern. The cyclical strength in part of the business is improving but the company also has meaningful exposure to industries in structural decline. The contrasting divisional performances highlight the good and bad and the broker deduces from this that the stock should not be a long-term holding but rather a trading stock. In this case, a cyclical uplift is needed across a number of markets simultaneously and that is not happening at the moment.

FNArena’s database contains six Buy ratings and two Hold for BlueScope. The consensus target is $5.79, suggesting 14.9% upside to the last share price. This compares with $6.02 ahead of the results. Targets range from $5.11 (Morgans) to $6.32 (Deutsche Bank).
 

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