Strong Steel Prices Underpinning BlueScope Outlook

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

Brokers welcome BlueScope Steel's FY17 outlook after a strong operating performance in FY16, with earnings momentum supported by steel prices for now.

-Several factors underpinning steel pricing in FY17
-Flat final dividend suggests company is intent on de-leveraging
-Capital returns may be more likely than increased dividends
 

By Eva Brocklehurst

Brokers are upbeat about BlueScope Steel’s ((BSL)) outlook after a strong operating performance in FY16. Cost and growth initiatives implemented over recent years are expected to deliver benefits alongside higher production volumes. Returns on invested capital should improve to 16% from 10% through the course of FY17, UBS maintains, although returns are then expected to moderate in FY18 as US steel prices correct from their current high levels.

Guidance for the first half is for earnings (EBIT) to be up 50% on the prior half, which the broker envisages being delivered on the back of better east Asian and US steelmaker spreads. The spreads refer to the difference between the price of the raw material and the price of the finished product. UBS suspects regional steel spreads bottomed at US$160/t in November last year and several factors, such as declining production in key regions in China and a step up in global protectionist measures, should limit the possibility that spreads re-test these lows.

The assumptions behind the company’s guidance are for east Asian spreads of $272/t and US spreads of US$350/t, Morgan Stanley observes, which compare with its forecasts of $250/t and US$280/t respectively. Embedding the company’s higher spread estimates implies an upgrade to expectations for the first half of FY17. However, since the broker expects spreads to normalise by FY18 its forecasts for that year are unchanged.

Macquarie remains impressed with the operating performance and the Australian and North American business. The broker continues to believe momentum is supported by US steel prices, which enjoy benefits from trade protection. While the investment case is maturing, on valuation grounds the broker retains an Outperform rating.

Despite the strength in the US, the company expects US mini-mill spreads will decline 10-20% in the second quarter of FY17. Given the quantum of the increase in US hot rolled coil (HRC) pricing in the second half of FY16 a pull back in the spread is not unexpected and cash flow still remains attractive, the broker maintains.

There was no further guidance on the Taharoa iron sands sale. Management is hopeful of renewing interest in the asset as it returns to profitability with higher iron ore prices. Macquarie had expected a higher dividend, given undemanding gearing and strong cash generation, but believes the decision not to increase the pay-out highlights management’s focus on preserving capital to weather downside risk.

The flat dividend, despite a materially better balance sheet and strong near-term outlook, clearly signals to Credit Suisse that the board wants to reduce leverage to secure the business in the case of future adverse cycles. Moreover, BlueScope can take advantage of opportunities which are presented during downturns rather than be a forced seller of good assets when times get difficult.

The broker notes that many in the market were concerned at the time when the first half dividend was reinstated ahead of any de-leveraging being realised. The broker believes the board made the right decision then and has now chosen to be more prudent. Moreover, while net debt will decline, finance costs might not budge as fast, Credit Suisse asserts. No additional cost reduction targets have been announced for FY17, which means the FY17 cost base for Australasia is essentially the same as that which existed in the second half.

In the US, Credit Suisse observes inventories are low, imports are down and demand is solid, while domestic mills have taken a significant amount of blast furnace capacity offline. Ultimately, the spread comes down to overall tightness in the US market and all factors listed above are supportive.

In Australia, Credit Suisse notes guidance implies the FY17 underlying cost base will be flat and earnings will be driven by spreads. The six months from July to December are seasonally the stronger half so domestic dispatches are expected to be higher. Observed steel spreads should have a positive impact at the start of the first half, once the earlier price spike takes effect with the usual lag. Credit Suisse expects spreads will then moderate from the start of the second half.

Assuming a 0.5 times net debt target, Goldman Sachs believes the company could deliver up to $200m in in additional returns to shareholders in FY17. Goldman, not one of the eight stockbrokers monitored daily on the FNArena database, has a Neutral rating and $9.76 target. The stock remains the broker’s preferred exposure in Australian steel, with a positive influence expected to be exerted further into the first half of FY17 from the recent rally in steel prices.

Also, the full impact will be felt from the cost reduction program in Australasia and completion of strategic initiatives. Still the broker accepts the investment case is not without risks. All global steel stocks are highly leveraged to global steel prices and the volatility in Chinese demand. Citi also liked the performance and guidance and believes the focus on reducing debt signals capital returns rather than higher dividends are more likely to be on the horizon.

Ord Minnett is impressed with the first half guidance, noting the better operating leverage and higher production from Australian steel as well as volume and margin growth for coated products in Asia. The company is targeting growth above GDP in key Asian markets for its coated products and will add an additional metal coating line in Thailand to meet improving demand, which should enter commercial production from FY19.

Deutsche Bank expects the first half of FY17 will likely be the peak for earnings as steel spreads have started to come under pressure and the decision to pay a final dividend of 3c, lower than expected, implies a degree of uncertainty prevailing over the volatility in steel spreads. The broker suspects, even the significant expectations for earnings to increase in the first half, the company’s net debt target may reached as early as the first half results.

FNArena’s database has four Buy ratings and three Hold. The consensus target is $9.33, suggesting 3.2% upside to the last share price. Targets range from $7.86 (Deutsche Bank) to $11.03 (Citi).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms