BlueScope Guidance Still Conservative?
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Strong US steel margins have caused BlueScope ((BSL)) to upgrade second half guidance by 12%, now expecting FY18 second half operating earnings (EBIT) of $680m. The increase is mainly because of realised steel spreads, which have increased strongly for the North Star mill in Ohio. Upgraded guidance implies FY18 operating earnings of around $1.2bn.
Several brokers believe the announcement remains conservative for the current year and envisage further earnings and valuation upside if US prices hold up. Ord Minnett calculates that guidance implies North Star spreads are US$95/t higher than the first half.
The broker upgrades FY19 forecasts to reflect the assumed strength in US steel prices but reduces FY18 estimates because of a delay in anti-dumping measures into FY19 and also to reflect higher zinc and aluminium prices. As a result, the broker forecasts operating earnings of $719.3m in the second half, imply a $1.24bn outcome in FY18.
US hot rolled coil (HRC) prices have climbed steadily since the announcement of US steel tariffs in March. Prices have now settled at elevated levels, having spent 65 days within 5% of the current spot price of US$972/t, Ord Minnett observes.The broker calculates that, for every three months the current pricing remains firm, BlueScope grows full year earnings by around $130m.
The upgrade implies a strong start to FY19 and US import tariffs are supportive as is China's capacity management and global growth expectations so Citi assesses, as does Ord Minnett, that the latest upgrade underpins capital management initiatives.
Citi's US steel analysts consider the fundamental backdrop is the strongest for several years and there is potential for an extended period of elevated prices if exemptions are not extended, or other countries agree to import quotas similar to Korea. The sharp drawdown in Chinese steel inventory confirms a seasonal pick-up in demand is underway and this appears sustainable to the broker.
Morgan Stanley agrees strong cash flow and a more aggressive stance on capital management represent the next leg of upside for the business. The broker retains estimates that run ahead of guidance, noting that BlueScope provided first half guidance in December last year and went on to report a substantially better outcome two months later.
Amid good visibility over the remaining six weeks of the second half, Credit Suisse had suspected a higher upgrade was possible, and agrees higher reported FY18 earnings could still be possible.
The broker notes the upgrade is largely attributed to stronger US steel spreads as well as modestly stronger Australian steel products, partly offset by lower contribution from the ASEAN operations within the building products JV.
UBS suspects the market is now finding it difficult to firm up expectations for FY19. Spreads have historically averaged around US$300/t but strong US demand, concerns over tariffs and the possible rollover of medium term contracts all combine to suggest spreads will be higher in FY19. UBS increases FY19 estimates by 25% to US$375/t which drives a 20% upgrade to earnings estimates.
Meanwhile, the broker suggests the ASEAN division is struggling. Volumes and margins are now expected to be lower as general business activity and foreign investment slows down with elections in several jurisdictions. This should be somewhat temporary but the strength of the US is considered to be only partly offsetting the ASEAN weakness.
Credit Suisse suggests the underperformance in the ASEAN operations will be the focus of the new chief of this division, now based in Singapore, and resolution of Malaysia's political transition should also mean a recovery in that country, with perhaps a slower turnaround in the Thai business.
Morgan Stanley calculates the company will be in a net cash position in the second half with more than $2.5bn in free cash flow forecast to FY20. The broker expects a doubling of the buyback to $600m per annum in FY19, which still provides surplus cash flows to pursue growth initiatives.
The challenge for brokers is what lies ahead for steel spreads in FY19 and what, as Credit Suisse points out, to assume when the current US tariff protection benefits to US earnings might abate in FY20.
Although spot spreads are well above its FY19 forecasts Morgan Stanley is reluctant to factor in continued outcomes of this magnitude. Nevertheless, should the current dynamics continue the broker acknowledges meaningful upside exists.
Credit Suisse acknowledges its FY20 earnings now look conservative in the context of current spot spreads, albeit realistic relative to historical averages. While the implied collapse in FY20 forecasts looks precipitous and unlikely, projecting current spot spreads from those prevailing in the first half of FY18 would have appeared equally preposterous, the broker suggests.
Credit Suisse has no doubt that a shortage of HRC in the US is supporting elevated prices and there is capacity to import HRC and pay both freight and a 25% tariff and still make margin on higher US domestic prices.
Nevertheless, the broker does not believe there are material re-start opportunities in the US that would mean a sufficient near-term increase in US domestic production to improve the current supply/demand balance.
Elevated US imports of scrap also signal it is now economic to bring scrap into the US, while also improving the domestic supply situation and constraining the local price.
In the final analysis, Credit Suisse envisages no justification for adjusting its spread assumptions in FY20 to reduce the current gap to spot spreads, or to achieve an FY20 earnings outcome that would support the maintenance of the current share price.
FNArena's database shows six Buy ratings. Targets range from $16.90 (Credit Suisse) to $20.50 (UBS). The consensus target is $19.10, suggesting 6.2% upside to the last share price.
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