We have lowered our forecasts for FY11 / FY12 on the back of OST's recent earnings downgrade as well as BSL's recent investor tour to Port Kembla.
Impact
Guidance for a breakeven reported NPAT (excluding NRVs) in 2H11 appears optimistic. We note that the 4Q of FY11 remains a key swing factor for 2H earnings, with higher steel prices, a recovery in earnings in BSL's North America Hot Rolled Products division and continued strength from Asia areas of potential upside. However, in our view these will not be enough to offset the significant headwinds in terms of higher input costs, the rapid escalation of the A$ and continued softness in domestic demand.
While downgrades to near term earnings are important, the bigger issue remains FY12 and whether BSL's domestic steelmaking and distribution operations can make a positive contribution to earnings. The former ?Coated and Industrial Products Australia' (CIPA) division is of particular importance and remains the key swing factor for Group earnings.
Cost pressures are likely to continue weighing on spreads. While any lift in global steel prices will be a positive, higher coking coal prices as well as sustained strength in iron ore will continue to weigh on BSL's cost base. A structurally higher level of raw material costs is likely to drive thinner spreads for BSL, in our view, which will ultimately see a lower level of profitability versus prior periods.
A s ignificant reduction in ?mid - cycle' earnings : We note that BSL's average ROFE over the last 7 years has been 21%. However, in a new environment of structurally lower spreads and a higher A$, we believe the mid-cycle ROFE should be lower than what BSL has enjoyed in the past.
Our A$1.70 target price assumes a mid-cycle ROFE of 7% and an EBITDA multiple of 5.0x. This sees 10% upside from the current share price.
Earnings and target price revision
We have lowered FY11 EPS from -2.6cps to -3.2cps. We have lowered FY12 EPS by 28%. We have reduced our target price from $2.10ps to $1.70ps.
Price catalyst
12-month price target: A$ 1.70 based on a EV/EBITDA methodology.
Catalyst: Currency / East Asia and US steel prices.
Action and recommendation
We maintain our Neutral recommendation with a revised $1.70ps target. The medium-term outlook remains challenging for BSL, and while many longer term valuation metrics appear compelling at current levels, we highlight that there is likely to be significant volatility and hence risk around earnings .
BSL Price at posting:
$1.30 Sentiment: Hold Disclosure: Held
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