Concerns surrounding disruptions to BlueScope Steel's business are ebbing, encouraged by first half earnings guidance that is well ahead of prior forecasts.
-Demand for housing/renovations underpins Australian activity
-Yet could this be simply a pulling forward of future demand
-North Star could push the US market into oversupply
Demand is running in BlueScope Steel's ((BSL)) favour, despite lingering concerns regarding disruptions stemming from the pandemic. The robust outlook is particularly the case for Australian construction, although Southeast Asia and India have improved notably.
First half earnings guidance is $340m, well ahead of prior broker forecasts and an increase of 30% on the prior half. Robust volumes were recorded across the business in the first quarter and East Asian steel prices are also improving.
In the US, where the automotive industry is recovering, North Star continues to dispatch at full capacity. Macquarie finds a number of supportive aspects in the company's update, including Australian construction, US automotive volumes and stronger realised spreads (the difference between the raw material and finished product price).
Ord Minnett calculates a free cash flow yield of 4% in FY21, rising to 7% in FY22, and now expects Australian Steel Products (ASP) to generate $192m in earnings (EBIT) because of higher coke profit and volume growth as well as slightly better prices. A minor improvement in New Zealand is expected.
The stronger cash flow should facilitate capital management too, with Morgan Stanley now forecasting a FY21 free cash flow yield of 14%. A reactivation of the buyback is expected from the second half of FY21.
As always, Morgan Stanley believes spreads will be the main driver of earnings and these are well likely to deliver an even stronger second half, although the current share price is assessed to be capturing the improvement.
Citi now assumes Australian domestic dispatches are flat in FY21. Government stimulus appears to be working well for home builders and alterations & additions are particularly strong. This could be a pulling forward of future demand, the broker warns.
Hence, it is unknown what sort of growth will occur in FY22 as stimulus rolls off. How much is a catch up with demand and how much is a pulling forward is open to debate, UBS agrees, albeit the risks are still to the upside for BlueScope Steel.
Greater demand for detached housing and renovations has underpinned Australian activity and the broker assesses BlueScope continues to take market share from tiles and timber framing. Such tailwinds are unlikely to abate, which provides upside risk to ASP earnings. UBS forecasts 4% per annum growth over the next three years for Colorbond, to 49% of total ASP volumes.
Colorbond is already around 50% of new detached homes in Australia, supported by its superior access in regional areas compared with tiles, and as it is lightweight this allows for greater spans in construction. Moreover, the pandemic could push more buyers into areas that favour Colorbond.
While North Star did not contribute to the materially better performance in the first half, Ord Minnett suggests the improved earnings profile is still impressive because of the elevated capital expenditure required for the North Star expansion.
Morgan Stanley notes steel production capacity in the US has been fairly stable over the past 10 years and as a best-in-class asset, North Star typically operates above the industry average of 60-80%, having run at close to 100% since 2011.
Credit Suisse finds building products in North America and Asia are often under-appreciated relative to the earnings potential of ASP/North Star, and while still envisaging risks around volumes because of pandemic-related disruptions accepts the risk is moderating.
Building products in Asia and North America will deliver a considerably better performance in the first half , Citi believes. Both Southeast Asia and India have improved significantly, the broker adds, although remain subject to the risk of disruptions.
Spot steel spreads are at $346/t for ASP and US$367/t for North Star, which point to stronger realised spreads in the second half. UBS forecasts a first half spread of US$270/t for the latter, lifting to US$300/t in the second half, with US$260/t for the long-term.
US steel supply remains constrained, which is underpinning high steel prices and spreads that are well above the long-term average, the broker adds. Still, while high spreads could persist for longer than previously expected, the trajectory is heading lower.
UBS also believes it likely North Star will put the market into oversupply. The local North Star market is expected to be around 10% oversupplied by 2023 and this is why BlueScope Steel has a very conservative 18-months ramp-up.
The broker points to more US electric arc furnace production and China's re-entry the scrap market as risks for the company. Around 50% of North Star steel production is sold into the automotive industry with the remainder split between construction, agriculture and other industries.
FNArena's database has three Buy ratings and three Hold. The consensus target is $16.07, suggesting 0.7% upside to the last share price. Targets range from $11.50 (Morgan Stanley) to $19.20 (Ord Minnett).
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