Treasure Chest | Jun 09 2020
FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. BlueScope Steel stands out as a tactical buy for several brokers as global demand for steel recovers.
-Economic stimulus measures globally should underpin steel demand
-A material pick up in US automotive sales needed
-First quarter of FY21 expected to be the low point
By Eva Brocklehurst
BlueScope Steel ((BSL)) continues to defy the pessimists and several brokers believe there is an opportunity in the stock, given the market appears to be pricing in depressed earnings for the foreseeable future.
Moreover, as economies slowly open up and governments across the globe engage with economic stimulus, amid low interest rates, there is increased confidence in what is being done to restore activity.
Along with that will come demand for steel. Credit Suisse has conducted a review across the BlueScope business segments and, while reducing estimates for FY21 because of lower steel spread assumptions (the difference between the raw cost and finished price) and softer Australian volumes, believes the business is well placed to deliver ahead of consensus forecasts.
The trading environment is uncertain but the broker considers there is a value opportunity on even a partial restoration of what could be considered reasonable mid-cycle trading conditions in earnings, and there is upside for those willing to look beyond the current pandemic-affected demand and spread pressures.
Significantly, while some operations completely ceased during the height of the pandemic, such as in New Zealand, or were curtailed (India, Malaysia), Australian steel products, the largest component of the business, continued to operate.
Goldman Sachs expects improvement in steel spreads over coming months with a more consistent supply/demand environment. The first half outlook is now more positive than previously assumed and the broker upgrades FY21 estimates by 31%. FY21 is now considered to be the first in a three-year recovery back to more normal earnings.
The steel sector, globally, has re-rated in recent weeks although, for a further re-rating and material improvement in share prices, the broker believes there will need to be evidence of improved earnings in terms of both spreads and volumes.
Overall, demand remains lower than prior to the pandemic but early curtailments on the supply side have mitigated a potential oversupply. Goldman Sachs calculates the average sector enterprise value/EBITDA (operating earnings) multiple has rallied materially, to around 6.5x, and is now at levels not seen since early 2017. Still, this is below the multiples experienced at the start of the recovery from the GFC in 2009.
While there were some concerns in March and April that rising inventory in China would again flood the seaborne market and put downward pressure on spreads, this appears to have been largely unfounded. Goldman Sachs assesses east Asian spreads have re-based at floor levels and are set to deliver a sustained rebound to the middle of the US$130-210/t range.
In the US, a reignition of automotive production has helped sentiment and supported recent pricing. US steel spreads have found a floor at around US$300/mt, assisted by regional supply reductions and some pricing tension is now expected to re-emerge.
Credit Suisse concedes it is difficult to make an assessment of North Star, the company's US business, particularly in the knowledge that 50% of its sales go to the automotive industry. A re-start of that industry in the US is positive but a material pick up in sales will be needed to restore demand volumes to pre-pandemic levels, in the broker's view.
Ord Minnett agrees steel spreads at North Star have stabilised, although capacity utilisation remains below 55%. Hot rolled coil prices have risen about 10% since the start of May.
The pandemic is unlikely to have had a material impact in Australia as it appears construction activity that had already started, or was fully funded, continues unabated. The risk lies with the first half of FY21, Credit Suisse asserts, amid a lag in future activity decisions. The broker points out the alterations & additions market accounts for around 20% of Australian volumes and the first quarter of FY21 is expected to be the low point.
Yet, recent channel checks by Goldman Sachs provide visibility through to August and confirm that concerns regarding a hiatus in demand have passed. The effective control of viral activity across the Australian market and absence of stage 4 restrictions have ensured residential construction has continued.
The economic slowdown and lack of new activity does present some concerns for the December half, while the broker believes the Australian government's new $688m home builders stimulus should help.
Meanwhile, non-residential construction demand has been relatively weak and concerns over office over-supply have meant very few new projects have started. Nevertheless, engineering remains well supported as local governments seek opportunities for infrastructure stimulus.
Agriculture stands ready for a recovery in demand as the drought breaks and steel use is likely to increase with reconstruction following the bushfires. Hence, Goldman Sachs is now forecasting domestic steel demand to be down just -5-10% across the December half.
Importantly, BlueScope has the balance sheet to ensure it can navigate the current challenges and Credit Suisse assesses it is well-positioned to prosper as a genuine cyclical stock that is leveraged to macro improvement in aggregate recovery in demand. For Ord Minnett the worst is behind BlueScope, in terms of steel pricing, and the stock stands out as a "tactical trade" into the recovery.
Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, upgrades to Buy from Neutral, with a target of $14.95. The database has three Buy ratings and three Hold. The consensus target is $11.47, suggesting -7.3% downside to the last share price.
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