BlueScope’s Outlook A Little More Rosy

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

-Accelerated cost reductions
-Challenges for NZ iron sands
-Positive price momentum slows
 

By Eva Brocklehurst

BlueScope Steel's ((BSL)) outlook appears a little more rosy. The company has upgraded guidance for the first half by 28% and for the second time since the August results.

The upgrade relates to better profitability in Australia, particularly in the Colorbond division, as well as the earlier delivery of cost reductions stemming from the company's restructure announcement last October.

For brokers, the upgrade does not signal the end to problems posed by low prices in the steel industry. Renewed price pressure is expected as supply returns to the market after the Chinese New Year.

Management will increase the carrying value of its Northstar business by $700m, reflecting the price paid in October for the buy-out of its joint venture partner. This will be offset by a $570m impairment covering steel manufacturing operations, including $350m for New Zealand and Pacific Steel.

Ord Minnett commends the early delivery of cost savings and considers the outlook is now heavily dependent on the price direction for steel post the Chinese New Year. East Asia hot rolled coil spreads fell 28% in 2015, the broker notes, but have rebounded 18% from their lows to reach $225/tonne recently.

Positive momentum has now eased, the broker adds, with spreads coming back over the past three weeks as negative inputs from currency and raw materials have coincided with flat steel prices.

Macquarie suspects the extent of the NZ impairment means there could be a change in the wind for the iron sands operation. The broker's focus is now on the cost reductions and how much can be obtained now the pace has quickened. The fundamental change instigated by the new enterprise agreement at Port Kembla could have a substantial impact over time. The company is considered to be doing well in a tough market.

Credit Suisse was also pleased with the upgrade but finds the announcement short on detail. The $200m target for cost reductions previously supplied could now be conservative and subject to revision. The broker suspects the restructure could set the business up to generate earnings once steel pricing spreads improve, noting spreads recently deteriorated and this will require additional cost reductions to be found and implemented.

The broker does not believe the Australian steel making is generating cash as yet, but Port Kembla's break-even point has been reduced further. Credit Suisse agrees NZ is deeply challenged by low steel and iron sands prices and was not surprised at the impairment sum.

As steel prices have declined by more than iron ore prices, and the NZ iron sands price is transferred at cost not market, the business is considered to be structurally challenged. Credit Suisse hopes to glean more information at the first half results on the potential for reductions in NZ iron sands exports.

Around half of this latest upgrade is sustainable into FY17, Morgan Stanley contends. The movement in the stock broadly reflects the upgrades that are probable and, should further momentum in cost cutting and the improvement in Colorbond profitability continue, earnings upside is considered likely.

The company seems to be targeting a debt/earnings ratio of 1.0 for FY17, the broker calculates, and this should be achieved without any asset sales. Nevertheless, further upside is envisaged should asset sales be forthcoming, or the iron sand business is closed. Alternatively, the broker believes a higher pay-out ratio could be initiated above the current 20%.

Morgan Stanley derives its FY17 forecasts off East Asian spreads of $205/tonne and evaluates that, after the latest asset adjustments, the stock is still trading at a 40% discount to book value.

UBS recently upgraded to Buy from Neutral, believing the recent rebound in spreads is sustainable in the near term. While acknowledging it was too early to call a bottom in the market the broker expects BlueScope will benefit from an improvement in pricing spreads.

In sum, there are six Buy ratings on FNArena's database with a consensus target of $5.60 that suggests 10.5% upside to the last share price. The target compares with $5.46 ahead of the upgrade. Targets range from $5.30 (Credit Suisse) to $5.90 (Macquarie).
 

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