BlueScope May Have Peaked

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

-Steel prices likely peaking
-More cost cutting to come?
-Positives seen mostly priced in
 

By Eva Brocklehurst

BlueScope Steel ((BSL)) has raised its guidance for the second half of FY16 by 29%, reflecting higher steel and iron ore prices, stronger domestic volumes and earlier realisation of cost savings.

Steel prices rallied in the first half of the year as global demand fundamentals improved, particularly in China, underpinning the stock. Nevertheless, broker views diverge as to how much further upside exists. BlueScope has also signalled North Star has resumed full production after an outage on May 7, with the costs in line with guidance of $5m.

The improvement in the second half largely stems from the pull-forward of cost reduction initiatives and better-than-expected volumes in the domestic business in a traditionally seasonally weaker period. Of note, UBS observes the improvement in steel spreads and commodity prices, around 20-30% since February, has only contributed to some of the guidance upgrade, which paves the way for further improvements in the first half of FY17.

Steel spreads have turned positive since November, with mills generating a positive cash margin since March. Yet UBS believes the bias from here is to the downside, in the absence of a sustained turnaround in demand. Hence, with most of the positives priced into the stock, the broker downgrades to Neutral from Buy.

Ord Minnett also takes the opportunity to downgrade to Hold from Accumulate, suspecting regional steel spreads have peaked. Chinese government support is weighted to the first half and increased production is likely to dampen pricing, the broker adds. While updated guidance provides relative certainty regarding near-term earnings, Ord Minnett finds no catalysts that could readily lead to a positive surprise.

In contrast, Goldman Sachs reiterates a positive view and believes the FY17 earnings outlook continues to strengthen. The broker calculates the recent steel price rally, cost reductions, new product initiatives and NZ restructuring all combine to deliver a 30% year-on-year rise in FY17 estimates.

Goldman, not one of the eight stockbrokers monitored daily on the FNArena database, recommends buying into weakness and retains a Buy rating with an $8.10 target. Nevertheless, in the near term, the broker suspects the stock will remain volatile as the market evaluates the exposure to falling East Asian steel prices amid a positive outlook for FY17.

Citi, too, welcomes the upgrade and expects momentum will last into the next financial year. The broker prefers the steel output exposure of BlueScope to that of inputs such as iron ore, base metals and coal. The revised guidance is also 17% above Credit Suisse's forecasts, with six weeks of exposure to stronger spreads factored in compared with prior guidance.

The broker suggests that while the quantum of targeted cost cutting has not been revised, this early success could indicate there is more to come. Credit Suisse also assumes a $60/t contraction in the steel spread from the current spot spread and expects a lower iron ore price will affect NZ earnings. Still, the broker believes earnings forecasts already take account of these lower spreads and maintains an Outperform rating.

Trends in commodity prices could act as a headwind in the months ahead, Macquarie contends. The broker considers the stock is comparatively inexpensive, while there remains some prospect of upside to cost reduction targets, and suspects the prospect for further improvement on this front stems principally from the gains associated with a revised enterprise agreement at Port Kembla.

Deutsche Bank is nonchalant about the upgrade, suggesting  consensus forecasts were 9.0% ahead of the prior guidance already, and retains a Hold rating. The broker also notes some moderation in the recovery in East Asian hot rolled coil spot spreads over the past month, declining $59/t to $336/t since April 25.

There are four Buy ratings on FNArena's database, where there were six back in February, with three Hold. The consensus target is $7.08, suggesting 15% upside to the last share price. Targets range from $6.09 (Deutsche Bank) to $7.67 (Citi).
 

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