Comparative review

For the past decade or so, deciding what recommendation to put on BlueScope Steel has been an easy one—it’s an extremely tough, capital-intensive business and it was horrendously overpriced. The call is no longer easy. The business is still tough but the stock is no longer clearly overpriced. In fact, it looks quite cheap, and the business appears well advanced in its turnaround from both an operational and financial perspective.

Over the past few years, the company has raised capital and paid down debt, restructured its operations away from exports (where it held no business edge) and taken some much-needed write downs on its balance sheet. Midway through the year, it announced the sale of its coated products business into a new joint venture with Nippon Steel Sumitomo Metals Corporations (the world’s second largest steelmaker). When the deal settles, in a few months, BlueScope will retain half the business and receive net proceeds of US$540m, making it almost debt free. To boot, recent government anti-dumping reforms might help reduce the onslaught of foreign competition in Australia.

When it comes to turnarounds, our preference is to wait until they’re well underway (and therefore more certain) before getting involved, even if that means paying more for the stock. Adjusting for the recent 1-for-6 share consolidation (completed today), BlueScope shares have approximately doubled over the past 6 months. But there could be more in the offing, the stock still trades at barely half its reported net tangible assets (NTA). Allowing for the consolidation, the stock price is down 76% since our last review on 16 Aug 10 (Sell—$2.41) and we’re going to revisit the stock in the new year. For now, though, we’re upgrading to HOLD.

The share price of Arrium (formerly OneSteel) has also almost doubled from the lows earlier this year, a response to a bid of up to 88 cents per share by a consortium that included Noble Group, Korean steel giant POSCO and numerous Korean investment groups. The consortium pitched at 88 cents per share (near the current price) and was subsequently rejected by the Arrium board.

No longer is Arrium a straight steel play but a conglomerate of steelmaking and recycling and iron ore mining and export. Don’t let the name of the bidding consortium—Steelmakers Australia—fool you. The group was (is) mainly interested in Arrium’s iron ore and port operations. Arrium has been expanding its iron ore mining operations at the Middleback Ranges near Whyalla and the recently developed and curiously named Peculiar Knob, way outback near Coober Pedy. The expansion will lift iron ore export sales from around 6m tonnes per annum to around 12m by next year. The Whyalla port operations have also doubled in size to accommodate, at a cost of roughly $200m. Arguably, the iron ore operation is now the most valuable part of the company, though the timing of the expansion hasn’t proven ideal with iron ore prices falling over most of 2012 (though recently recovering quite sharply). Also it should be noted that there is turnaround potential in the steel operations and there may be value there.

The stock trades at a 25% discount to its $1.20 NTA but, unlike BlueScope, the group is fairly heavily indebted, with net debt of more than $2bn (versus a market capitalisation of $1.2bn. Given the debt and our general concerns about iron ore, we’ll maintain a negative slant in our recommendation for now. But, as with BlueScope, we’ll take a closer look soon. AVOID.