Ann: Half Year Results - 22 February 2011 , page-9

RBS report:

OneSteel
Iron ore fortifies the result
OST's 1H11 underlying NPAT of A$125m was in line with our expectations, with
iron ore again delivering the bulk of group earnings. Despite continued
challenges in domestic steel markets, we see investment appeal in OST's 9x
FY12F PE and leverage to strong iron ore prices. Buy maintained.

Iron ore compensates for losses in steel manufacturing
OST?s 1H11 underlying NPAT of A$125m was in line management?s guidance and our
expectations. Management also announced a 6cps unfranked interim dividend.
Compositionally, earnings from iron ore sales were the dominant positive driver of the result,
as the impacts from a rising AUD:USD and high raw material costs, caused the steel
manufacturing business to post its largest EBIT loss since demerger. No financial guidance
for 2H11 earnings was provided by management.
Steel price increases in 2H11 anticipated to ease margin pressure
Following a rally in international steel prices, OST has announced price rises of 7-20% to be
implemented over February-April 2011. Our forecasts apply a more conservative 5% price
increase in 2H11. While we anticipate challenges to achieving higher prices due to high
AUD:USD and import competition, management has suggested initial success thus far. We
estimate every 1% increase in achieved prices above our estimates, would increase our
FY11 EBIT forecasts by A$15m.
Strong iron ore prices expected to continue to underwrite near-term earnings
We anticipate OST?s earnings will continue to benefit from strong iron ore prices, which have
risen a further 10% since the beginning of 2011. Our forecasts estimate 6.25Mt of iron ore
sales in FY11 and 6.35Mt in FY12, which we believe will provide support to group earnings
while a recovery from OST?s steel operations slowly takes shape.
Buy maintained ? near-term valuation appeal with steel recovery leverage
At 9x FY12F PE, OST is trading at a discount to international steelmaking peers at 11.5x,
based on Bloomberg consensus, and only slightly above comparable iron ore peers at 8.5x,
based on our estimates. In our view, this provides near-term valuation appeal, enhanced by
a 5% dividend yield. With the added benefit of steel market recovery exposure longer term,
we retain our Buy rating with an NPV-based target price of A$3.12ps (from A$3.15ps).

Changes to forecasts and valuation
Our FY11 NPAT forecasts remain relatively unchanged following the 1H11 result. On a divisional
basis, we have lowered our FY11 forecast earnings from iron ore sales due to lower expected
volumes in line with management?s guidance of roughly 6.25Mt. We have also lowered our
forecast manufacturing earnings, which have been offset by mildly stronger earnings expectations
in Australian and New Zealand distribution and a lower effective tax rate due to R&D tax credits.
The decrease in our FY12 NPAT forecasts relates primarily to a softer forecasted margin recovery
in the steel manufacturing business. Changes to our near-term earnings have lead to a slight
decline in our NPV to A$3.12ps (from A$3.15ps).

Key 1H11 result summary
􀀟 1H11 underlying NPAT of A$125m was in line with our A$124m forecasts.
􀀟 Interim dividend of 6cps (unfranked), was held stable over 2H10. Management stated it
expected franking to recommence on dividends in FY12.
􀀟 Divisionally, earnings were near exclusively driven by iron ore EBIT of A$276m compared to
an EBIT loss in the manufacturing business of A$71m.
􀀟 Gearing lifted to 30% (ND/ND+E), post the completion of the debt funded Moly-Cop and Alta
Steel transactions in 1H11.
Management outlook and comments
􀀟 Management did not provide financial guidance for 2H11.
􀀟 Australian steel: March quarter margins continue to be impacted by lower steel prices. June
quarter margins anticipated to improve due to announced price increases effective February-
April. Some steel volume recovery is anticipated in 2H on the back of government funded civil
works projects (roads and highways), and continued strength in the resource and mining
consumables segment.
􀀟 Iron Ore: Iron ore sales forecast near the middle of a 6.0-6.5Mt range (including 2Mt of 58-
60% medium grade ore). This guidance is a moderation from previous ambitions near the top
end of the range, due to the impacts of extreme December and January weather conditions.
􀀟 Recycling: International business expected to see improved 2H earnings. Australian trading
conditions for scrap are expected to remain challenging until the supply of new arisings
improves. Management believes robust steel raw material demand should support current
high ferrous scrap prices.