Buybacks Underpin BlueScope Steel

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

BlueScope Steel provided a disappointing update for the market, downgrading earnings guidance amid soft building product volumes in both Australia and North America.

-Late cycle nature of the company's building products could have a delayed impact
-Concerns about sanctioning of North Star expansion as steel spreads are below viable levels
-Further $250m in buybacks announced for first half FY20
 

By Eva Brocklehurst

BlueScope Steel ((BSL)) has provided the downgrade many brokers were expecting after they assessed the narrowing of steel spreads in the wake of recent US tariff increases. However, the market is also disappointed with the update on building products, amid soft volumes in both Australia and North America.

The downgrade to guidance implies a -9% reduction to second half earnings (EBIT). The company is expecting earnings growth of 6% in FY19 versus 10% previously, and guiding to EBIT of $1.35bn. UBS was not surprised, given the known weakness in steel spreads (gap between the buying and selling price of steel). The broker's second half spread estimate is lowered by -US$20/t to US$374/t.

The company has also pointed to softer than expected conditions in Asia and North America and weaker margins in volumes in buildings in North America. Building products in North America have been affected by longer customer lead times.

Australia is performing in line with initial expectations, as pricing has been better than expected and has offset weak demand. However, the company did not discuss this in detail, which leads Ord Minnett to be cautious, suspecting BlueScope Steel could be foreshadowing some impact in FY20 from is shifting sales mix.

The company has signalled to date that it is insulated from declines in home construction, given exposure to alterations & additions and with limited exposure to multi-residential. Still, the broker is concerned that, because of the late-cycle nature of the building products such as roofing, there could be a delayed impact.

UBS recently surveyed 40 steel buyers and 70% expect prices to be soft over the next three months. The broker cuts its FY20 spread forecast to US$255/t from US$300/t, the primary driver behind a -14% reduction to its FY20 estimates. This is partially offset by a lower Australian dollar.

Credit Suisse believes the trajectory of US and Asian spreads implies a materially weaker exit rate from FY19, and downgrades estimates for FY20 for the fourth time. The main queries the broker has are about where spreads will settle before improving, and how quickly building product volumes turn around.

The broker assesses prior down-cycles have been exaggerated by supply chain de-stocking and this results in distorted volume and price signals, setting the cycle up for an aggressive rebound when prices trough. To date, steel liquidity has not evolved into an increase in Chinese steel exports, despite record production. Credit Suisse believes it is critical to the outlook to ascertain whether Chinese exports will stay well managed, and whether declining profitability will initiate production cuts.

Strong fundamentals, including a circa-15% free cash flow yield, provide value through the cycle but Morgan Stanley asserts spreads still need to get better for this to be realised. The broker expects reduced spreads to persist in the short term, noting US and east Asian steel spreads are at their lowest point since 2016/17. A strong appreciation in raw materials in east Asia has caused the spread to narrow by -27%.

Morgan Stanley considers the stock by no means expensive and likes the fundamentals, albeit remains concerned about the trend. Hence, it will difficult for the stock to perform while the trend is negative. Macquarie is also concerned about the earnings momentum and envisages -35% downside risk to FY20 earnings on current spot settings. Citi, on the other hand, believes the downside risks are factored in and the risk/reward has turned favourable.

North Star

There are likely re-rating catalysts as steel markets bottom, Citi asserts, while the potential approval of the expansion at North Star and an ongoing buyback program are also supportive. Deutsche Bank, meanwhile, expects North Star spreads could fall another -US$50/t by FY21.

Ord Minnett is also concerned about the sanctioning of the North Star expansion in the current environment, as spreads are below viable levels and there are rumblings about oversupply in the US. The broker would prefer the North Star expansion was deferred.

Macquarie is worried about momentum, particularly given the US steel market outlook, and a North Star expansion decision is not factored into its estimates. The company continues to evaluate the expansion of North Star, commencing detailed design and engineering procurement and costing around US$50m. An update is expected in August.

Buyback Continues

The company has announced a further $250m in buybacks as part of its first half capital management. In contrast to prior years, BlueScope Steel expects to continue buyback activity during July 2019 and Citi believes this signals confidence in strong cash generation and a view that the shares are cheap.

The broker expects the company to maintain a $500m per annum buyback program and also fund growth projects. Macquarie now assumes a full $250m in the first half of FY20 and $420m for the financial year overall.

The extension of the buyback indicates the company is confident in the balance sheet cash outlook, Credit Suisse agrees, despite signs the North Star expansion will proceed.

FNArena's database shows three Buy ratings, three Hold and one Sell (Macquarie). The consensus target is $12.63, signalling 12.0% upside to the last share price. This compares with $14.31 ahead of the downgrade. Targets range from $9.20 (Macquarie) to $15.00 (Ord Minnett, Credit Suisse).

See also, BlueScope Steel Squeezed As US Tariffs Lifted on May 28, 2019.

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