Earnings diversity yielding dividendsSteady earnings from iron...

Earnings diversity yielding dividends
Steady earnings from iron ore sales and leverage to recovering domestic steel demand, make OST our top pick in the steel sector. With support from a FY11 dividend yield of about 6% and attractive valuation metrics on an NPV, EV/EBITDA, and P/B basis, we maintain our Buy recommendation.

Domestic steel demand recovery starting to build
We anticipate strong steel demand growth over FY11 led by infrastructure and the resourcessector. While the full ramp-up of these projects is not expected until 2H11, stabilisation in residential and commercial construction and improving corporate capex spending appears to be supporting near-term demand. Steel production data for July-August suggests OST’s mill utilisation is running slightly above management’s implied 1H11 guidance of 89-91%. We estimate every 1% increase utilisation lifts FY11F NPAT by 2.2%.

Valuation upside on comparable peers multiples
While our price target is based on our sum-of-the-parts NPV, we see additional value on both a comparative peer multiple and a long-term P/B basis. Applying an average FY11F EV/EBITDA multiple of iron ore steel, and building materials sector peers we arrive at a valuation of A$3.58ps. On a long-term price to book value multiple of 1.2x, this implies a valuation of A$4.72ps.

Highest dividend yield within the steel and mining sector
At a dividend yield of 6% for FY11F, OST has the highest yield across our Australian steel and mining coverage. This provides the dual benefit of higher total shareholder returns, as well as providing a level of support against potential share price decline, in our view.

Buy recommended – earnings support, recovery leverage and strong yield
OST’s iron ore sales provide the best earnings support in the steel sector, while improving steel production off a low FY10 base should deliver more leverage vs BSL to domestic steel demand recovery. With support from attractive valuation metrics on a comparable peer and
long-term P/B basis, as well as a potential 6% dividend yield, we retain our Buy rating. We have lowered our NPV-based target price of A$3.35ps, (from A$3.95) due to our lower steel price forecasts over FY11-12 and our more conservative long-term steel margin assumptions.