Ann: Half Year Results - 22 February 2011 , page-10

Morgan Stanley report:

February 23, 2011

OneSteel

Iron Ore the Driver

What's Changed

Price Target A$3.66 to A$3.47

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.