Interim earnings: OST�s underlying interim EBIT result was A$215m, vs. A$199m in the pcp. The result was driven by the iron ore business, which posted an EBIT for the half of A$276m, a 144% increase on pcp. This was offset by the steel producing business (manufacturing), with negative EBIT of A$71m, vs. a profit of A$72m in the pcp. Similar to BSL, OST�s steel manufacturing and distribution business was hampered in the half by a stronger A$, sluggish demand and higher raw material costs. OST recorded an unfranked dividend of 6 cents, implying a dividend yield of 4.2% (assuming full year dividend of A$0.06/sh). Risk to the upside for iron ore: Strong spot iron ore pricing (~US$192/t) is greater than our FY11 forecast of US$158/t. Assuming our bull case iron ore price of US$183/t in FY11, our iron ore EBIT contribution increases to A$739m (base case forecast A$632m). Near the bottom of the Australian steel cycle: OST is trading on a one-year forward PE multiple of 9.3x, comparable to other Australian iron ore miners. If we strip out the iron ore assets from our OST valuation, the company�s steel operations currently trade on a one-year forward PE multiple of ~15x. However, in our view, the Australian steel cycle is near the bottom and thus our FY13 earnings multiple of 7.9x is more relevant. In FY13 there is a strong prospect that steel pricing and demand will have recovered, representing both upside to earnings and valuation from current levels. We rim our earnings estimates but retain our OW rating. Long steel pricing improving: Although Australia�s construction index is trending down, OST believes this does not reflect the increasing activity in the engineering sector. OST expects improving demand in Q4 from a number of national civil projects. In addition, international long steel prices continue to trend up � supporting our view for an improved 2H performance.
Why Overweight?
� A vertically integrated long steel producer, including the supply of iron ore to its own and customer (~6Mtpa) steel mills operated in Australia and overseas.
� Leading supplier of long steel products to the domestic market.
Despite our subdued view for domestic steel demand, one positive area of potential surprise is increased mining and infrastructure activity in Australia.
� Our top of the market iron ore pricing expectations are driving OneSteel�s earnings growth. � Strong balance sheet position. � Limited capital growth options for steel domestically.
Key Value Drivers
� East Asia long steel prices. � Iron ore prices. � Global scrap prices. � Australian construction activity. � A$/US$.
Upside Risks
� Stronger than expected recovery in steel demand. � Increase in export iron ore volumes. � Limited import competition. � A$/US$ weakness.
Downside Risks
� Unscheduled production outages. � Introduction of Emissions Trading Scheme. � A$/US$ strength.
OST Price at posting:
$2.86 Sentiment: Buy Disclosure: Not Held