BlueScope is cheap, but are there risks?

We recently researched BlueScope Steel (ASX:BSL) in The Dynamic Investor. The large drop in the share price since its recent high of ~$24 in mid-April prompted us to consider whether the shares present a more attractive entry opportunity. Having come off a lower level since our report, are the shares due for a recovery?

About BlueScope Steel

BlueScope Steel is a flat steel producer for the domestic Australian, NZ and US markets. The Company is a leading international supplier of steel products and solutions. Its principal focus is on the global building and construction industry. Operations are structured into five divisions, with the main contributors to revenue and earnings being the Australian Steel Products (ASP) and Building Products Asia and North America divisions, as well as the North Star operation in Ohio (US). North Star is a single Electric Arc Furnace (EAF) producer of just one product, hot roll coil (HRC).

Key Fundamental Drivers

US Steel Spreads Remain Depressed

By way of background, ‘steel spreads’ refers to the difference between the steel price (both domestic and export) and raw material input costs. US steel spreads are a key sensitivity for BSL’s earnings. The Company has provided guidance for earnings (EBIT) of between A$620-690m for the 2nd half of financial year 2024 (2H24). The 2H24 EBIT guidance range is predicated on a US spread of US$510/t and Asian benchmark spreads of ~US$145/t.

The decline in HRC prices – from ~US$1140/t at the start of the year, to ~US$690/t at the time of writing – have lowered US steel spreads to ~ US$400/t currently. This level is below the US spread of US$510/t assumed by BSL in its 2H24 EBIT guidance. This suggested downside risk to consensus 2H24 EBIT estimates of ~$670m, given that minimal offset is expected from Asian steel spreads. Current Asian steel spreads are only marginally above the Asian benchmark spreads of ~US$145/t assumed by BSL in its 2H24 EBIT guidance.

US steel lead times provide one of the best lead indicators of steel prices & spreads. Currently, US lead times sit at ~5 weeks, which is well below the highs of ~9 weeks reported in March and November 2023. This suggests that US steel prices (and spreads) are set for an eventual recovery.

US Downstream Strategy Has Potential to Add Value

The BlueScope Coated Products (BCP) operations account for <30% of total despatched (volumes) for the North America division. However, the contribution to North America division’s EBIT was ~40% given that BCP is a higher-margin business.

BCP’s performance in 1H24 was impacted by several challenges. These included the integration of seven under-utilised paint lines in 2022 (following an acquisition) and delays in updating poor systems.

Once near-term operational headwinds at BCP are resolved, the Company can begin to focus on executing a growth plan for BCP. BSL is currently advancing feasibility work into expanding and integrating its US value chain
through the potential addition of 550Ktpa of cold rolling and metal coating capacity into its operations. The proposal would involve leveraging its low-cost North Star steel mill asset HRC feed to underpin painted growth.

The key opportunity entails taking the product mix (including North Star-produced coil) further downstream on the US East Coast. In context, two-thirds of US painted steel demand originates on the US East Coast. BSL expects US painted demand in the building and construction industry to grow by ~20% between 2020 and 2030, with much of that growth on the East Coast.

There are two key industry tailwinds that support BSL’s ‘downstream’ strategy, including increased channel take-up and fiscal support.

Balance Sheet Capacity Remains Strong

The balance sheet remains in a robust position, with a net cash balance of $614m and liquidity of $3.2b as at 31 December 2023. This provides the Company with the opportunity to pursue further growth. In particular, BSL continues to see the consolidation of the US steel industry as a structural tailwind. Other than Merger & Acquisition opportunities, BSL can undertake capital management. This entails distributing >50% of free cashflow in dividends and further share buybacks.

Surplus Land Portfolio to Support CAPEX Requirements

The Company faces significant CAPEX requirements over the medium term, as it undertakes a range of projects across the US and Australia/NZ). There are seven major investment projects in study phase with possible execution between FY23-FY27. BSL has identified ~$1.9b in project spend over the next four years excluding $350-400m per annum of sustaining CAPEX. These projects include the ramp-up in production at North Star as well as upgrading and expanding shredding facilities at its recycling & materials operations.

At the 1H24 results release in February, BSL outlined how its significant land portfolio (1,200 hectares) has the potential to reduce the CAPEX burden. While the land portfolio is difficult to value, there is sale and/or development potential.

Fundamental View

BSL shares currently trading on a 1-year forward P/E multiple of ~9x. While this multiple place the shares in value territory, we highlight several reasons for a cautious view:

i. The recent decline in spreads presents downside risk to consensus EBIT estimates for 2H24. In turn, this has the potential to delay the expected earnings recovery in FY25.
ii. Near-term operational headwinds at BCP need to be resolved before the market shifts its focus to the potential value upside in the Company pursuing a downstream strategy in the US.
iii. While sale/development opportunities regarding surplus land is value-accretive in the long-term, there are significant CAPEX requirements over the medium term. In turn, this is pressuring free cashflow, which may result in reduced capital management and/or reductions in dividend payments. To this end, BSL shares have historically held capital management appeal.

Charting View

At the start of April, BSL hit the top of its trading range and then eased back. There is some support here and it seems to be holding for now. The stock is a tentative buy and initial stops can therefore be considered just under last week’s low.

BlueScope Steel (ASX:BSL) weekly chart
BlueScope Steel (ASX:BSL) weekly chart


Michael Gable is managing director of Fairmont Equities.


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