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Morningstar | Peak Steel Spreads Deliver Strong but Unsustainable 1H 2019 Result for BlueScope; Shares Overvalued

Unsustainably strong steelmaking spreads in Australasia and North America saw no-moat BlueScope deliver record first half underlying EBIT of AUD 850 million. The result tracks our expectations and with East Asian and U.S. Midwest hot rolled coil (HRC) prices having retreated since September 2018, we continue to expect a moderation in the second half. Our full-year underlying EBIT forecast of 1,312 million is unchanged, as are our midcycle steel price assumptions. With our fair value estimate of AUD 8.70 per share also unchanged, BlueScope continues to screen as significantly overvalued, trading at an approximate 50% premium to our fair value estimate.

BlueScope’s North Star delivered record EBIT of AUD 412 million on strong U.S. steelmaking spreads that improved to USD 524 per tonne in the first half. Midwest HRC prices were their highest in a decade, benefiting from President Trump’s steel tariffs announced in March 2018. Segment margins soared to 29.8%, up from 16.8% a year earlier. But with steel pricing now moderating, we forecast North Star’s full-year steelmaking spread at USD 415 per tonne and continue to expect full-year North Star EBIT of AUD 722 million.

The Australian Steel Products (ASP) segment also benefitted from elevated steel prices. East Asian HRC prices have been buoyed from Chinese supply side reforms and averaged USD 586 per tonne in the first half, a 21% improvement from the prior year. With Australian residential construction at cyclical highs, sales mix during the period remained favourable. As such, ASP sold 71% of segment volumes into high-value added steel building product markets, unchanged from a year earlier. But we expect spreads to moderate and forecast full-year ASP spreads of USD 300 million per tonne, down from USD 350 per tonne in the first half. At the group level, we continue to forecast an operating margin in fiscal 2019 of 10.8% but see margins declining with steelmaking spreads to 6.3% in fiscal 2023.

With net cash of AUD 128 million at half-year end, BlueScope’s balance sheet moved considerably closer to its new net cash target of AUD 200 million to AUD 400 million through the cycle. We continue to view the net cash position positively given the inherent cyclicality of the steel business.