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Treasure Chest: Questioning BlueScope Steel Takeover Talk

Treasure Chest | Nov 24 2020

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

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. The media suggests private equity has its eye on BlueScope Steel, but Citi, for one, questions why?

-BlueScope Steel guidance upgraded three times in a month
-Private equity looking to split up the company
-Is there really value to unlock?

By Greg Peel

Having provided maiden first half FY21 guidance on October 23, BlueScope Steel ((BSL)) has since raised that guidance no less than three times. The upgrades have been driven mostly by demand for the company’s steel products in Australia and New Zealand, but also rising demand in Asia and improved US steel spreads.

In simple terms, the world has gone mad for Colorbond, particularly downunder. Take a drive out to a recent housing development. See if you can spot a tiled roof or a paling fence.

Typically such rapid revisions to guidance frustrate analysts, as they imply management were clueless at the beginning. But no one minds as much if the revisions are positive, and in this case analysts have been just as caught out as management by surging demand.

On October 23 the consensus target price for BlueScope Steel among the six FNArena database brokers covering the stock was $14.51. Today it’s $18.93. That said, the split of ratings has not changed in that period from three Buy and three Hold.

BlueScope and those who analyse the company have been caught out particularly by the extent of housing construction/renovation growth in Australia in the Year of Covid. Initially, it was assumed the virus would kill off demand for some time. Indeed, this was the case back in the earlier national lockdown, given such construction was considered non-essential.

But slowly restrictions were eased, and in the meantime the federal government decided housing was one of its preferred areas for directed fiscal stimulus. Handouts were provided to first-home buyers. The Treasurer has urged regulators to ease off lending restrictions.

The RBA has chimed in with as good as zero cash rates.

It was also assumed that with an international border still closed, and thus immigration collapsing, demand for housing would also take a hit. Not so. The locals are hitting the market in droves.

It then becomes a matter of how long can it last?

Writing last week, Credit Suisse (Outperform) suggested BlueScope Steel is a high-quality cyclical with strong competitive positions in key markets, a diversified product and geographic base and increasing leverage to the key US market. Macquarie (Outperform) continued to foresee strong earnings momentum.

But while noting volumes and pricing are working in the company’s favour in virtually all markets, Morgan Stanley (Equal-weight) advised caution in extrapolating this into the long term. Ord Minnett (Accumulate) suggested BlueScope is set to deliver top-of-the-cycle earnings for FY21.

Top-of-the-cycle. That’s important.

The Australian Financial Review has since suggested private equity firms are looking at BlueScope Steel as a potential play on US infrastructure spending. We note that Trump always promised such but never delivered, but Biden has put infrastructure towards the top of his to-do list as a means of supporting an economic recovery.

Private equity’s intention, the AFR suggested, would be to split up BlueScope by region and in so doing potentially unlock value to the tune of $25 per share (last trade $17.24).

Citi is not so sure.

While private equity funds are able to access cheap US funding, managing currency exposure and the risk of buying at or near a cyclical high in steel prices and margins makes such a takeover a less likely event, Citi believes.

And that’s before one considers the share price has risen 68% in six months. There’s hardly a case for misguided undervaluation.

Citi notes the enterprise value to earnings multiple of the ASX Industrials sector has been expanding in line with the reduction in government bond rates. BlueScope’s consensus forward enterprise value multiple has expanded to 7.0x, which is one standard deviation above its long term average of 5.3x.

Plug in Citi’s own earnings forecasts and the stock is trading on an FY21 enterprise multiple of 5.5x, or roughly fair value.

Citi acknowledges the rationalisation of Australian blast furnace capacity has much reduced BlueScope’s exposure to the ups and downs of export steel pricing, while the company’s North Star (US) expansion has provided for earnings upside. How does this stack up against the AFR’s $25 value suggestion?

On an FY25 enterprise value multiple in line with the through-the-cycle (longer term average) multiple of 5.3x, Citi estimates a share price of $22.50. Make that multiple 7.0x and you get $27.50.

“However, 4 years is long time in the steel industry and we could see another price cycle before this point – and this would be a substantial risk for any potential suitor. While we can see a longer dated value case for BSL, we look for mid-term steel spreads to contract with rising scrap inputs and stay Neutral rated.”

Citi has an $18.50 target on BlueScope. Targets range from $16.00 (Morgan Stanley) to $21.20 (Ord Minnett).

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