BlueScope Outlook Improves Markedly

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

BlueScope Steel's fundamental position has improved markedly, brokers observe, and plans to pay out 30-50% of free cash flow have been welcomed.

-Now focussed on growth with capital expenditure on high-returning internal areas
-Subdued Chinese steel exports and US protectionism supportive
-Magnitude of capital management underpins broker sentiment
 

By Eva Brocklehurst

Cost reductions and capital management are at the top of BlueScope Steel's ((BSL)) agenda. In its first half results, the company appears on track for at least $300m in cost reductions in FY17, having already achieved $150m. BlueScope has also announced a $150m on-market share buy-back. The board intends to pay consistent dividends along with buy-backs, planning to pay out 30-50% of free cash flow.

Having improved the fundamental position of the business, Macquarie observes the company is now focusing on growth. Much of the capital expenditure will be on high-returning internal areas, where incremental capacity and efficiency can be gained. BlueScope is targeting a two-year pay-back on many of its investments.

The stock has an attractive relative valuation versus the ASX 200 and international peers, and this underpins the upside case for Macquarie. Its US business, North Star, continues to feature highly in the stock's performance, while improving construction and oil & gas markets are envisaged more than compensating for slightly slower demand in the automotive area. North Star is operating at 100% utilisation and further process optimisation aims for a 90,000 tonnes per annum capacity expansion.

Macquarie notes a sale of Taharoa would support debt reduction and a further buy-back. The sale is proceeding, with two interested parties in advanced negotiations. Compared with international peers the stock is inexpensive and Macquarie, while cautious on commodity price progression, maintains a Outperform rating.

International Conditions Supportive

The positive investment context is supported by subdued Chinese steel exports and US protectionism, brokers believe. Credit Suisse's main concern is that a portion of the surprisingly strong North American building product performance in the half year could have been an outcome of profit in stock, where the business would have benefited from inventory gains stemming from lagging input steel prices for product awaiting conversion.

The downside of US protection is that the company's cost of steel substrate for conversion to its building products has risen and accessing steel is getting more challenging. At present, however, the selling price differential to the highest substrate cost is favourable. Credit Suisse acknowledges that, in common with all steel and resource analysts, it has been conditioned by market experience to be bearish at best and pessimistic more generally. The broker is now less confident that China's new-found discipline will not be sustained and that US protection will fail.

The sale of the Arrium assets is one uncertainty, domestically, that overhangs the stock. There is some modest risk that a foreign owner could acquire the company's steel-making, pipe and tube, and distribution assets and use this as a conduit to the domestic market.

Nevertheless, the broker notes, in light of Chinese steel capacity cuts and stronger domestic demand, surplus Asian steel seeking an export market is declining. Management has stated that domestic hot rolled coil prices to pipe and tube makers are extremely competitive, making the domestic tube market unattractive for exported hot rolled coil.

UBS was impressed with the first half results and believes a combination of cash losses by most Chinese steel mills, declining Chinese exports and a step-up in global protectionism should help limit the probability that steel spreads could retest previous lows. The broker envisages upside to its modest volume growth outlook for the company's Australian steel business.

Ord Minnett is more circumspect, forecasting earnings will be reaching a cyclical peak. As the stock is approaching the broker's valuation, and despite the attractive multiples, the broker downgrades to Hold from Accumulate. The broker agrees the capital management initiatives should help support the stock but forecasts earnings momentum to slow.

The broker also accepts that productivity gains are continuing to flow through at Port Kembla and, given the high level of fixed costs, additional volumes are an incremental positive to the bottom line, even if they are directed to the lower value export market. Deutsche Bank also retains a conservative stance, continuing to rate the stock Hold as the share price is broadly trading in line with its target price.

Tax Effective Strategy

Credit Suisse upgrades to Outperform, noting a lack of franking credits means dividends are not tax effective for shareholders. The broker notes the low multiples versus peers make the stock look cheap, particularly if earnings are now at mid cycle and broadly sustainable. The magnitude of capital management and the intention to sustain this surprised the broker in a positive way and signals that there are many incremental, low capital expenditure opportunities that can be readily funded.

Citi agrees. As the balance sheet is in pristine condition, there is more than sufficient capacity in cash flow for the company to engage in an annual on-going share buy-backs of $100m per annum, in addition to maintaining an unfranked distribution of $0.14 per share from FY18. The broker highlights BlueScope's structural advantage enables it to deliver positive shareholder returns through the cycle.

As global steel spreads are favourable and there is ongoing strength in iron ore this will support a meaningful contribution from the NZ iron sands operation as well, Citi asserts. The broker revises up forecasts for earnings per share by 18% and 13% respectively for FY17 and FY18.

Morgan Stanley considers the company's guidance for second half EBIT of $510m conservative. The broker believes there is scope for further upgrades throughout the course of the second half. The capital management plans were delivered earlier than expected and Morgan Stanley is most impressed with the plan to buy back 30-50% of free cash flow per annum.

While not explicitly including these numbers in its forecasts, the broker calculates that the cumulative buy-back could be up to $1.1bn by the end of FY20. This would be around 6.4% accretive, assuming a share price of $12.50 and a cost of debt of 5.0%. As the balance sheet is largely un-geared and earnings risks are to the upside organ Stanley retains a Overweight rating.

There are five Buy ratings on FNArena's database and two Hold. The consensus target is $13.71, signalling 6.7% upside to the last share price. This compares with $12.18 ahead of the results. Targets range from $11.73 (Deutsche Bank) to $15.00 (Citi, UBS).
 

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