eureka report, page-10

JP Morgan comment:

Investment thesis
While OST has had a strong recent run compared to peer BSL, returns have been
modest compared increases in iron ore spot prices given its considerable net long
iron ore position. The chart below shows OST?s indexed share price performance
versus spot iron ore fines prices and pure play iron ore company FMG. The
underperformance is notable.

Is OST now an undervalued iron ore play primed for a re-rating? We think there are
several factors relating to OST's steel manufacturing and distribution businesses that
have to date prevented such a re-rating and we believe will continue to weigh on the
stock post its 1HFY11 results. These factors include:

? Jun-11Q Whyalla blast furnace outage. OST is planning a shut down lasting
approximately 7 weeks to replace and update corroded refractory panels. The
timing of the shutdown is ideal as OST will be able to offset the lost production
by selling magnetite pellets, hematite lump and coke that would otherwise have
been used in the furnace. Additionally, the forthcoming shutdown will be a
controlled event rather than the uncontrolled shutdown which resulted in a
protracted outage last year. Despite all efforts by OST, blast furnace repairs do
however carry with them an inherently high risk and we think the market may be
hesitant to hold the stock while these repairs are incomplete.

? Domestic steel demand environment. OST's core exposures are residential
construction, commercial construction, infrastructure and mining
construction/consumables. We think the commercial construction remains very
weak in Australia and infrastructure investment (notwithstanding the Australian
Rail Track Corporation supply deal - ~120kt of carbon rail over the next 18
months) has suffered deferrals post-GFC. We are concerned that the outlook
statement provided with OST's 1HFY11 results will point to continued weakness
in these key market segments.

? Impact of high A$ on import competition. OST is impacted by a high A$ both
directly in terms of the revenue translation effect on export iron ore sales and
indirectly in the form of increasing the competitiveness of imported products.
The most recent ABS figures point to a surge in Dec-10 monthly long steel
imports into Australia as shown in the chart below. We note that the bulk of the
import increase is in the pipe & tube segment, with rebar and other products
remaining relatively flat. OST has had issues with pipe and tube dumping in the
past (from China primarily). We believe that a significant part of the Dec-10
increase in pipe & tube imports may be explained by product specifically
imported for the new Epic Energy pipeline project in Queensland. OST is
supplying ~50kt of the total ~155kt pipe requirement for the project and is
coordinating the import of the remaining product. Despite the plausible
explanation for the increase in Dec-10 imports, we think the high A$ will
continue to raise concerns about the ability of OST to push through domestic
price increases to recover margin levels.

We are retaining our Neutral recommendation on OST. Our DCF valuation of
A$3.32/shr offers comparatively less upside to current share price levels than our
DCF valuation for BSL.

Accounting of Moly-Cop acquisition and restatement of Manufacturing segment
The acquisition of the Moly-Cop and AltaSteel businesses from Anglo was
completed at the end of 2010. As such, cash flows from 1 July 2010 until end
1HFY11 will be included in the OST balance sheet as an offset against the asset
purchase price. Despite the transaction having an effective date of 1 July 2010, OST
did not have control of the assets for most of the reporting period therefore it cannot
eports the earnings through the P&L. We note that OST?s 1H11 earnings guidance
of ~A$117m (in line with 1HFY10) excludes any contribution from the new grinding
media businesses over the period. OST will provide pro-forma earnings for 1HFY11
and three prior years reflecting the new grinding media business which will include
Moly-Cop and AltaSteel and OST's current Waratah mining consumables business.
We believe that the restatement of accounts will magnify the poor operating
environment and performance of the manufacturing business excluding what was
likely to have been a high margin earning mining consumables business.

Queensland flood impacts
We believe that OST will see a long run net benefit in demand from the recent
Queensland floods, there will however likely be a short term negative impact.
Queensland comprises approximately 20% of OST's national and the period of
disruption and subsequent inactivity post floods will reduce this have an impact on
sales in the short term. The longer term rebuild effort should result in a sales uplift
that will more than offset the initial period of weakness. Of the estimated ~30,000
homes that have been inundated (pre-Cyclone Yasi) approximately one quarter will
need to be reconstructed which will support rebar demand. Large numbers of
wharves, rail infrastructure and fencing will need replacing which will support
structurals, pipe & tube and wire demand.