Is BlueScope At Peak Earnings?

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

BlueScope Steel beat expectations with its FY18 results but several brokers suggest this may be the peak.

-Option of expanding North Star being considered
-Target for increasing capital management now in sight
-Strong commercial & industrial activity compensates for residential slowdown
 

By Eva Brocklehurst

A buoyant steel market underpinned FY18 results for BlueScope Steel ((BSL)), in particular in the US. US steel spreads have leveraged the scarcity of steel that has been driven by US trade restrictions. FY18 results beat most expectations, with net profit of $1.57bn, supported by US EAF steel-making.

First half guidance for underlying EBIT is 10% above the prior half, implying an annualised $1.64bn in FY19. The company has also expanded its share buyback program and announced a study into the expansion of its North Star mini mill. BlueScope delivered its fourth consecutive half year EBIT above $500m.

Morgan Stanley increases FY19 EPS forecast by 22%, driven by higher spread assumptions and expects the strong performance will continue. Cash generation should enable capital management, in the broker's view, while still allowing accretive growth projects.

Macquarie was unimpressed with the expected 10% increase in first half EBIT, although acknowledges this is based on a US$0.76 Australian dollar rate and lower US spread relative to the current spot average, likely to be conservative. Challenges on the cost front also concern the broker, particularly in Southeast Asia because of the passing on of substrate cost increases.

Downstream businesses were generally less strong with the Nippon JV soft in most Asian regions. Credit Suisse points to the cause being external political uncertainties and poor execution in Thailand on the appliance coating initiative. The broker assumes a first half US steel spread of US$520/t and long run spreads in both the US and Australia of US$300/t.

The balance sheet is now within sight of a cash position of $200-400m, management's target before it considers adding to the buyback. The board has already pre-empted achieving this target, increasing the magnitude of the first half buyback to $250m from $150m.

Still, the shares eased. Citi suggests the company has been caught in a "peak earnings" narrative that has beset the global steel sector. A cyclical softening from a first half peak is likely, but the broker believes the company can still double its share buyback program in FY20 to $1.0bn, while funding its North Star growth project internally. UBS is not so sure this is the peak, pointing to little evidence one is occurring.

While trade wars in the northern hemisphere may be affecting sentiment, Citi notes prices are still holding at elevated levels. Meanwhile, China's steel market is underpinned by policies directed to pollution, demand is resilient and construction activity is firm. This is leading to a reduction in steel exports from that country.

Ord Minnett agrees with the assessment of an inflection point for the steelmaker, as this is BlueScope's best full year result since 2005. Problems such as leverage and unprofitable operations have given way to options for growth in capital returns. The broker believes capital returns are likely to increase materially, with a 50% pay-out ratio in the first half that implies a $500m buyback in February 2019.

North Star

North Star, Ohio, was the highlight of the FY18 results, in Citi's view. BlueScope has initiated studies on a $500-700m expansion of North Star milling to lift capacity by 600-900,000 tonnes or 30-43%. The US is currently the most profitable steel market in the world, with the additional volume likely to replace imports.

Based on the second half FY18 cash flows, Citi calculates payback would be in 18 months. The study will be undertaken over 6-12 months with a two-year development timeframe if approved. The investment must deliver an EBIT return exceeding the company's 15% hurdle through the cycle.

Morgan Stanley would normally be cautious about a decision to add capacity at this point in the cycle but considers North Star a high-quality asset that should generate attractive returns under most realistic price/spread scenarios.

Housing

Macquarie notes, in the context of the Australian housing cycle, the company was upbeat. Multi-residential exposure is limited for BlueScope and strong commercial, industrial and infrastructure activity appear to offset any slowdown in detached residences.

The US economy is also strong and business investment features in management's assessment of the market environment, as lower tax rates flow through. While Australian electricity costs remain a challenge the company expects these to moderate.

FNArena's database shows six Buy ratings and one Hold (Deutsche Bank). The consensus target is $20.43, suggesting 15.6% upside to the last share price. Targets range from $19.00 (Credit Suisse) to $21.40 (Macquarie).

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