OneSteelRe-basing expectationsEvent OST has provided earnings...

OneSteel

Re-basing expectations

Event

OST has provided earnings guidance for the 2H of FY11 for $116m, flat HoH and down 18% YoY. This implies a FY11 NPAT of circa $230m, versus consensus earnings of closer to $300m and Macquarie at $330m (reported).

Impact

The drivers of the softer-than-expected 2H were twofold. Firstly, the rapid appreciation of the A$ has impacted domestic steel volumes / margins and reported revenues from iron ore. Secondly, adverse weather has impacted shipments of iron ore, with OST now expecting sales volumes of circa 6m tonnes for FY11 (versus previous expectations for 6.0-6.5m tonnes).

Where to from here for OST? While downgrades to FY11 / FY12 are likely to weigh on the stock in the near term, we believe the investment case for OST remains intact with the bad news largely out of the way. Valuation remains supportive and the OST is well placed to benefit from any uplift in domestic demand as well as providing leverage to further strength in iron ore prices.

Manufacturing tough, but Iron Ore and Mining Consumables provide OST with better exposure to a two speed economy. OST's recent acquisition from Anglo will see 25% of revenue generated from mining and resources. However, with both Iron Ore and Mining Consumables generating margins significantly higher than OST's base steel business, the contribution to EBIT from the mining and resource sectors is likely to be far greater.

While we expect weak Manufacturing / Distribution earnings to weigh on Group return metrics, this is likely to be offset by stronger contributions from the higher margin Iron Ore and Mining Consumables operations. These divisions remain the main drivers of earnings growth in FY12, accounting for 78% of the uplift in EBIT for OST. We note that these operations have the effect of smoothing Group earnings through the bottom of the steel cycle as well as adding upside to medium to longer term earnings / margins for OST as returns improve in the steelmaking operations.

Our A$2.43 target implies a mid cycle ROFE of 12% and a mid-cycle EV/EBITDA multiple of 5.1x .

Earnings and target price revision

We have lowered EPS by 29% in FY11 and 36% in FY12. We have lowered our target price from $3.26ps to $2.43 on a ROFE basis.

Price catalyst

12-month price target: A$ 2.43 based on a EV/EBITDA methodology.

Catalyst: South America investor tour in early June 2011.

Action and recommendation

We retain our Outperform with a revised price target of $2.43ps. OST remains our preferred exposure in the domestic steel space. The company has good leverage to any upside scenarios for iron ore prices and remains relatively well placed to navigate a volatile environment for steelmakers.