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Morningstar | Steel Outlook Unchanged but BlueScope’s U.S. Expansion Accretes; Fair Value Estimate Raised 24%. See Updated Analyst Note from 15 Mar 2019

We increase our fair value estimate for no-moat BlueScope Steel by 24% to AUD 10.80 per share following a transfer of analyst, despite maintaining a bearish outlook on steel prices. Most of the uplift in valuation is discount rate related, with cost of capital revised to 10.2% from a prior 11%. BlueScope’s improved balance sheet position drives the revision. With the balance sheet in a net cash position, estimated cost of debt reduces to 5.8% from a prior 6.5%. The mooted North Star capacity expansion appears value accretive, and we lift our valuation a further 4% reflecting a 50% probability of the project being approved. But we see markedly lower steelmaking spreads prospectively, and BlueScope continues to screen as expensive in this context. Shares trade at a 25% premium to our revised fair value estimate.

We continue to anticipate a meaningful contraction in global steel prices over the forecast period, from current levels that have benefited from Chinese supply-side reforms and U.S. steel tariffs. At midcycle, we anticipate East Asian hot-rolled coil pricing of approximately USD 400 per tonne, down around 30% from average prices in 2018. Similarly, we expect materially lower U.S. Midwest hot-rolled coil pricing at midcycle, forecasting USD 520 per tonne--approximately 50% below average 2018 pricing. We therefore forecast group operating margins that contract to 7.9% at midcycle in fiscal 2023. While EBIT margins at midcycle will fall from cyclical highs of 10.7% in fiscal 2018, our midcycle EBIT margin has been upgraded from approximately 6%. Greater EBIT contribution from the anticipated expansion at North Star accounts for our revised margin estimate.

We expect that the proposed North Star capacity expansion will be approved. We view the expansion as value accretive, given the privileged nature of the North Star asset. We currently ascribe a 50% probability of approval adding circa 50 cents per share in value.