BlueScope Steel Outlook Not That Dismal

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BlueScope Steel opted for a conservative outlook when delivering flat guidance for the second half. While the market was disappointed, brokers point out the balance sheet is robust and capital returns are ongoing.

-Stronger Australian volumes, lower Australian dollar expected to underpin the business
-China business to have zero earnings in the second half
-Lowers second half buyback to $100m

By Eva Brocklehurst

Uncertainty hovers over BlueScope Steel ((BSL)) despite strong first half earnings, as the main focus of the market was on the flat guidance outlined for the second half.

The second half guidance was clearly not what the market was hoping for, Credit Suisse suggests, but this is not excessively dismal. Stronger Australian volumes, conservative pricing assumptions and the benefits of a lower Australian dollar are expected to underpin the business.

Coronavirus is a risk outside of the company's control and no explicit impact has been assumed beyond China, although there remains an earnings risk, the broker acknowledges. Still, the balance sheet is robust, which can support growth expenditure and ongoing capital returns.

Meanwhile, North America is underperforming. Earnings from North Star reflected weaker pricing after what Credit Suisse describes as a high and unsustainable FY19. However, demand appears stable and the business continues to operate at 100% capacity.

As demand for US steel is still weak, UBS does not expect higher prices will stick. Scrap prices are rising too. North Star's local market is forecast to be oversupplied by 10% by 2023. UBS suspects this is why BlueScope has been conservative about the ramp-up profile. Steel prices are expected to weighed down by weak demand and new supply.

The main offset is the potential adoption of hot briquetted iron, once construction is complete. This is an incremental substitute for scrap and could help maintain the North Star margin during times of low steel prices.

UBS upgrades to Neutral from Sell, given the outlook for Australian housing is improving and the company is taking share. Still, the broker is mindful of the execution risk at North Star.

Australian Housing

Australian steel products (ASP) sustained better Colorbond sales at the end of 2019 and this has carried into the second half. While value added sales lifted 5% this was against a decline in detached housing approvals of -13%.

UBS suspects the Australian housing market has passed the low of the cycle, particularly detached dwellings, and this underpins the ASP margins. Citi also lauds the Australian market strength and the weak performances from rivals.

China

BlueScope estimates China will deliver zero earnings in the second half, because of the impact of coronavirus in a seasonally weaker period. UBS also notes the Asian business faces structural headwinds from competition. Ord Minnett lowers second half steel price forecasts for eastern Asia, given the drop in spot prices. Still, the broker considers the stock cheap and maintains a positive investment view.

Credit Suisse highlights management's assessment that the best external indicator of the potential impact of coronavirus beyond China is regional Asian steel prices, and any marked deterioration below the current levels.

The broker suggests, as guidance assumes Asian steel will be in line with current spot pricing, this will be a data point that can provide some insight as the second half progresses.

Uncertainty still abounds, Morgan Stanley acknowledges, although longer-term value is emerging for BlueScope and the business has strong cash flow albeit in a highly cyclical industry. The company has specifically alluded to the impact of coronavirus on global steel markets so the broker finds it difficult to have conviction on the direction of steel spreads (the difference between the input price and the price of finished product).

Citi on the other hand considers the stock now at an attractive re-entry point. The company has prudently lowered the second half buyback program to $100m from $250m in the first half and the broker estimates this should offset higher capital expenditure.

FNArena's database has four Buy ratings and two Hold. The consensus target is $14.80, suggesting 17.0% upside to the last share price. Targets range from $13 (UBS, Morgan Stanley) to $16.50 (Macquarie, yet to update on the results).

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