Steel Prices Still Underpinning BlueScope

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

As BlueScope Steel revises guidance higher, once again, assessments of where peak earnings lie are becoming even more critical to the outlook

-Demand supporting the earnings outlook into FY22
-Are earnings nearing a peak?
-Potential for cash returns enhanced

By Eva Brocklehurst

BlueScope Steel ((BSL)) has developed a habit recently of revising guidance higher as its two principal earnings drivers, Australian Steel Products and North Star in the US, combine in a show of strength. The company now expects second half earnings (EBIT) to be $1-1.08bn, from prior guidance of $750-830m, driven primarily by improved steel pricing and volumes.

North Star stood out, which was no surprise to brokers given high spreads for hot rolled coil. Australian Steel Products also benefited from both high spreads and very strong domestic demand, particularly in high-value building products such as Colorbond. Building products margins in North America also expanded, supported by rapidly rising steel prices.

Ord Minnett shifts second half earnings forecasts to $1.06bn, with its FY21 estimate now 16% higher at $1.59bn and FY22 estimates at $2.07bn. The broker expects strong conditions will continue throughout 2021 and this should allow BlueScope Steel to shore up an impressive balance sheet and undertake capital management initiatives.

Over the next three months there is significant potential for upside and capital management, Morgan Stanley agrees, yet over the medium term, steel prices are expected to revert to the mean, although they could remain above historical averages for some time.

Moreover, running spot prices through the broker's modelling implies around 80% in upgrades to estimates that are already well above consensus. Morgan Stanley does not incorporate this into forecasts but anticipates a continuation of positive market trends.

FY22 earnings of $2.1bn are forecast based on conservative spread assumptions. The company has ended the first half with $305m net cash, enough to cover capital expenditure at North Star.

Peak Earnings?

Demand may be robust, enough to support the earnings outlook into FY22, yet Credit Suisse considers the company's earnings are nearing the peak of what can be achieved from the current asset base.

Diminishing returns to the share price are also anticipated from earnings upgrades and the broker assesses the market is rightly questioning the sustainability of earnings, noting the reluctance to pay for upgraded performance.

Could perceptions change? It is possible, Credit Suisse acknowledges, if assessments of mid-cycle earnings and the duration of elevated steel spreads are enhanced or extended. On balance, the broker considers the risk skewed to the downside amid limited capacity for more gains in the share price, downgrading to Neutral from Outperform.

Macquarie is of the same opinion and downgrades to Neutral, although suspects there will be more upgrades to consensus estimates after this update. The broker finds it difficult to envisage the environment improving further, with hot rolled coil prices in the US at US$1565/mt and in Asia at US$910/mt.

Citi upgrades FY22 earnings estimates by 22% to $2.05bn, and agrees this is likely to be the peak in the current steel cycle. Operating earnings margins of 17% may be impressive but unsustainable for steel companies. Furthermore, Citi remains reluctant to chase the earnings momentum trade, noting the shares in US dollar terms are up 47% over the last six months.

Ord Minnett understands the desire of some investors to take profits after the share price has more than doubled in the past year but has not encountered any sign that the steel market is softening. The broker emphasises a scenario where steel prices are strong into 2022 and material upgrades to estimates prevail, which could lead to significant excess cash being return to shareholders.

Ord Minnett's base case free cash flow yield is 15% in FY22 and this expands to 28% at spot prices. There are five Hold ratings and one Buy (Ord Minnett) on FNArena's database. The consensus target is $22.82, suggesting 6.4% upside to the last share price.

See also, BlueScope On Top Of The Housing Boom on February 1, 2021

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