Australia | Jan 25 2017
This story features BLUESCOPE STEEL LIMITED. For more info SHARE ANALYSIS: BSL
BlueScope Steel has upgraded earnings estimates for the first half and brokers welcome the work done to improve the outlook and balance sheet.
-Higher steel and iron ore prices, productivity improvements fuel guidance upgrade
-Management actions seen delivering on the upside, with capital management options looming
-Demand and supply in China's steel market could re-assert pressure in the second half
By Eva Brocklehurst
BlueScope Steel ((BSL)) has materially upgraded earnings estimates, with the biggest surprise for brokers emanating from building products, dominated by a stronger performance in the company's US operations, given higher steel prices and margins. India was also stronger.
The main drivers of the upgrade, with first half earnings guidance now $600m versus the “at least” $510m proffered at the AGM in November, are higher steel prices and spreads, particularly in Australasia. Stronger iron ore prices are also supporting the iron sands business along with productivity improvements and cost reductions. Management will recognise an impairment charge of around $65m, largely from the restructuring of the China buildings and Indian engineered businesses.
Progress In Debt Reduction
Macquarie retains its Outperform recommendation, noting a broad-based improvement which suggests the company's cost reductions are being realised and progressing ahead of plan. While the stock has had a good run, momentum is still considered positive in the near term. Market conditions are supportive, while management actions appear to be delivering to the upside, in the broker's view.
The stock continues to trade at a meaningful discount to global peers yet the investment case is not without risk, Macquarie acknowledges. The main issues are the demand and supply dynamics in China, which could reassert pressure on the steel market in the second half. Also, a maturing residential building cycle in Australia could present challenges. The broker notes the strong progress made in re-positioning the balance sheet, with net debt of $530m as of December 30 a little better than expected.
Nevertheless, stronger earnings have not generated a correspondingly strong cash flow, in Credit Suisse's view, confirming a suspected increase in working capital to fund higher iron ore, coking coal, scrap, coating metals and steel prices. Credit Suisse acknowledges that further debt reduction offers an opportunity for a more generous dividend while, in light of Chinese cuts to steel capacity and a stronger domestic outlook, surplus Asian steel seeking an export market is declining.
Credit Suisse downgrades to Neutral from Outperform on valuation grounds, also flagging the risk that a foreign owner could acquire Arrium's steel making and distribution assets and use this as a conduit to the domestic market.
More Value To Come
While acknowledging it is difficult to value the stock against recent history, because of the structural change in the cost profile of the steel assets in Australasia, UBS believes there remains inherent value within the franchise. The broker calculates that value exists even if steel maker spreads moderate from current peaks. Moreover, UBS expects US steel maker margins are likely to remain elevated for a longer period because of effective protectionist measures against imports, which may be underscored by the incoming US administration.
This means the broker's average US steel spread assumptions in FY17-19 rise to US$320/t from US$260/t, and this is the key driver of upgrades to its EBIT forecasts. Morgan Stanley also envisages building products have the largest area of upside in terms of the company's divisions, particularly in North America because of higher steel prices and margins.
City is bullish, believing the company is firmly on track to exceed the key $1bn earnings (EBIT) mark in FY17. The broker considers the stock a story of quality and low financial leverage. Several options exist for BlueScope, including opportunistic acquisitions, capital returns or an increase to the pay-out ratio. The broker lauds the work that has been done to re-shape the steel industry in Australasia and a raft of benefits from extremely challenging, but necessary, decisions which are now aligning to reward shareholders.
Ord Minnett raises its rating to Accumulate from Hold, noting most divisions are performing to expectations and capital management is likely to be a positive catalyst as debt rapidly reduces. The broker believes valuation screens as attractive on both a fundamental and relative basis.
Trade indicators have been positive, with Chinese net exports falling and BlueScope benefitting from increased trade action and price improvements. While Australian steel remains exposed to a peaking residential cycle improved diversity in earnings should reduce volatility, in the broker's opinion.
Deutsche Bank is more conservative, continuing to believe earnings, particularly in the New Zealand business, will face headwinds in FY18 should iron ore prices decline as expected. The broker upgrades FY17 net profit forecast by 25% and retains a Hold rating because of downside risk in FY18 and valuation.
FNArena's database shows five Buy ratings and two Hold. The consensus target is $11.97, suggesting 9.7% upside to the last share price. This compares with $10.37 ahead of the update.
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