Australia | May 28 2019
BlueScope Steel is confronting higher input costs and slumping prices for its steel products in the US and several brokers fear a downgrade to the earnings outlook is on the cards.
-Numerous factors squeezing steel spreads in the US
-Significant new US steel capacity forecast to come on line in 2022
-Is the outlook for North Star expansion affected?
By Eva Brocklehurst
As trade and tariff issues sweep across North America, BlueScope Steel's ((BSL)) FY19 guidance is under increasing pressure. US hot rolled coil (HRC) prices have softened following the removal of tariffs on Canadian and Mexican steel.
At the other end of the production chain, iron ore prices have surged. Additionally, the reduction in tariffs on Turkish imported scrap, another input for the company's North Star plant, is likely to mean scrap prices rise.
Ord Minnett estimates US steel spreads – the gap between input prices and steel prices – have fallen by -US$90/t since the company reported its interim result in February and the lagged US steel spread is now US$268/t. BlueScope Steel was expecting US steel spreads to rise back over US$400/t in the second half, and this has not eventuated.
Several brokers assess the potential for negative revisions to the company's estimates is acute. US/China trade tensions are also a risk to economic activity. Morgan Stanley already downgraded BlueScope to Equal-weight back in April, having noted a recovery in steel prices had stalled.
UBS downgrades to Neutral from Buy, citing the removal of Canadian and Mexican steel tariffs, higher iron ore prices and softening demand for detached houses in Australia. The broker reduces FY20 and FY21 earnings estimates by -36%. UBS estimates BlueScope Steel is pricing in a US spread of US$240/t versus spot of US$299/t.
Moreover, around 15mt of new US steel capacity is expected to come on line by 2022, almost entirely from EAF (electric arc furnace) producers and affecting mostly flat steel products.
The re-start of around 2.5mtpa of previously idled capacity in a 27mtpa market has put it into surplus and the price for HRC has slumped accordingly. Hence, Credit Suisse believes a collapse of HRC pricing in the US is inevitable, and will actually be required in order to force the closure of high-cost capacity.
Credit Suisse reduces US HRC and steel spread assumptions significantly, citing the expected capacity additions and declining tariff protection, as well as a likely rise in scrap prices. With tariff support gone, US domestic supply additions are likely to define US steel pricing, the broker asserts, and the removal of Canadian tariffs will mean freight-advantaged steel is likely to fight for US market share.
UBS counters that downside pressure could be dampened by Canadian and Mexican producers raising their prices into the US, although still selling sufficiently below domestic prices to recapture market share. UBS also enviages, with the pull back in US HRC prices, some of the expected re-starts may be delayed or cancelled.
Meanwhile, for the company as a whole, Credit Suisse believes BlueScope Steel's varied geographic and end-market exposures, as well as low production costs, will reduce its earnings volatility versus prior down cycles. UBS also believes recent changes to lending standards and a surprising federal election result have probably brought forward a floor in the Australian housing industry.
Macquarie acknowledges Australian end markets have actually improved, although volumes are likely to still be soft in the near term. Nevertheless, the broker points out, in the context of ongoing risks to assumptions from commodity prices, pressure remains on the downside for BlueScope Steel and downgrades to Underperform from Outperform.
Macquarie downgrades forecasts for net profit in FY20 by -16% and suspects, given movements in the spot market, there is risk of a further -35% downside to its revised base case. The broker's downgrade is driven by lower spreads amid pressure from input costs. Iron ore, in particular remains the challenge. In terms of iron ore prices, BlueScope Steel calculates a $10/t change affects full-year earnings (EBIT) by $60m, all else being equal.
North Star Expansion
Ord Minnett believes postponing the North Star expansion in favour of buybacks, to some extent, could be a more value-accretive proposition for shareholders. Given the volatility in US margins recently, combined with concerns the US steel market could become oversupplied, the sanctioning of an expansion to North Star could now be viewed as a negative.
Nevertheless, in the longer term the broker values the stock on the basis of mid-cycle steel spreads and maintains an Accumulate rating. Morgan Stanley, on the other hand, believes the formal announcement of the North Star expansion should provide a positive catalyst as the returns are potentially attractive.
Despite the weakening spreads, UBS expects the company will push ahead with the expansion, agreeing it is the right strategy for the long-term, and pointing out this is not an expansion but a removal of a bottleneck to maximise installed capacity of the hot strip mill. The upgrade is expected in the December half and nameplate production will be a further 1-2 years away from completion.
FNArena's database shows two Buy ratings, four Hold and one Sell (Macquarie). The consensus target is $14.39, signalling 26.7% upside to the last share price. Targets range from $10.15 (Macquarie) to $17.00 (Morgan Stanley). Added to this is the recent removal of tariffs on Turkish steel, likely to drive incremental demand for scrap steel.
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