Australia | Feb 28 2018
Improved global conditions for steelmakers, and particularly in the US, support the outlook for BlueScope Steel.
-Guidance likely conservative, based on pick up in Australian demand and current US spot spreads
-North Star spreads should benefit from trade action seeking to limit steel flow to the US
-Strategic review to assess options for the loss-making Asian buildings business
By Eva Brocklehurst
BlueScope Steel ((BSL)) is expected to finish FY18 with a flourish, amid improved global conditions for steel spreads along with US tax reform and Chinese capacity management.
Ord Minnett suspects BlueScope management, whose guidance appeared a little soft, is trying to be careful in what is otherwise regarded as a healthy macro environment for steelmakers, particularly those with US exposure. First half results were ahead of most forecasts and guidance points to full year operating earnings (EBIT) of $1.12bn.
Deutsche Bank believes guidance is conservative, based on the pick up in demand for Australian high-margin coated steel and current US spot spreads. Nevertheless, the broker retains a Hold rating with a view that earnings are close to peaking.
Reported earnings were boosted by a few one-off benefits, not assumed in the guidance provided in December, Credit Suisse points out. Yet the broker believes current guidance is conservative as spread assumptions for North Star are well below prevailing spot spreads.
In Asia, the building products joint venture is expected to be flat in the second half, reflecting soft project demand and selling prices that are lagging input cost increases. A stronger second half in New Zealand is expected, amid good demand and fixed steelmaking input costs.
Credit Suisse notes comments around the US Section 232 proposals were necessarily circumspect. Management's general view is that North Star spreads should benefit from any trade action that seeks to limit steel flows into the US, while the US west coast coating business, SteelScape, should be no worse off.
No significant need for project capital was identified in the medium term, suggesting cash could build on the balance sheet and capital returns continue. In this context a further $150m in buybacks was announced. Consumption of franking credits has meant the end of fully franked dividends until the tax losses at Port Kembla are consumed.
The company also wishes to maintain capacity to contemplate acquisition opportunities and is aware of a need to re-line the blast furnace in 15 years, or potentially exit commodity steelmaking in Australia.
Australian steel products were supported by a favourable product mix and price increases for Colorbond but with an adverse impact from continued dumping and strategic pricing to pipe & tube customers.
Citi envisages the Australian business requires additional focus on pricing, service levels and investment in capacity to improve domestic returns.
Australian infrastructure growth underpins strong domestic demand from the engineering sector for the company's products. Moreover, residential activity is performing well and Macquarie notes this supports high-margin Colorbond revenues. The broker points to the company's focus on returns targets and any M&A opportunities will need to clear specific hurdles.
Energy costs are a headwind, although the broker is encouraged by the fact the company was able to offset cost inflation through productivity in the first half. Macquarie believes the current guidance provides potential for upside and a supportive US macro environment should elevate spreads above current forecasts.
The company's buildings earnings more than doubled to $34m in the first half because of a strong recovery in North America. Yet Credit Suisse believes expanding the buildings division was a strategic error that is progressively being exited to an underlying profitable core, dominated by the US. The broker suggests peripheral business could be readily excised from the portfolio.
Citi agrees an exit of the buildings business would be a good move, given sequential periods of underlying losses generated by the Asian segment. A strategic review has been announced to assess options and Citi envisages, if the company exits these businesses, a -$15-20m underlying earnings drag would be removed.
The earnings improvement would be welcome but, even more importantly, senior management time and attention would be reclaimed. Although the macro factors are helping the outlook, Citi's long-term thesis is based on the company being properly recognised as a building materials company rather than a pure commodity steel producer.
FNArena's database shows one Hold rating (Deutsche Bank) and five Buy. The consensus target is $17.43, signalling 6.3% upside to the last share price. This compares with $16.03 ahead of the report. Targets range from $15 (Deutsche Bank) to $19 (Macquarie).
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