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 MARKET REPORTS |
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Stock picks
Stock of the week – OneSteel
August 11, 2008
Tim Morris, wise-owl.com analyst
Company: OneSteel
Code: OST
Recommendation: Buy
Market Cap: $5.9bn
Our recent buying spree in Aussie blue chip stocks have focused on value, buying shares in ‘beaten down’ household brand name companies and holding for the long term. The alternative to this value approach is growth, which involves picking companies with the ability to outperform due to strong earnings outlooks. The number of growth opportunities has weakened in current market conditions, however, OneSteel stands out through its resilience to date. Over the last year, OneSteel has remained steady, posting a flat return, which is very strong in the context of the overall market’s fall in excess of 28%.
The out-performance is a common trait throughout the global steel sector with US Steel Corp (NYSE code: X), the largest U.S. based steelmaker by market value, and Arcelor Mittal (NYSE code: MT), the world’s largest steel maker, both defying current trends on Wall St by posting earnings that far surpassed expectations in recent weeks.
The earnings strength is attributable to rising global steel prices, which have doubled over the last year in response to capacity constraints amongst suppliers and ongoing growth in global demand. However, it is not all-free sailing, as key steel making inputs such as iron ore and coking coal have also soared in price. Some of the world’s largest steel makers from Japan, such as Nippon Steel and Sumitomo Metal Industries, have posted lower earnings due to such raw material cost pressures.
US Steel Corp’s recent results confirmed that vertical integration is a key factor in managing such pressures, being partly self sufficient in iron ore. OneSteel is even better placed in this respect, being completely self sufficient in iron ore terms to the extent that it is actually a net iron ore exporter.
A key competitive advantage is that OneSteel’s iron ore mines are situated just 60 kilometres from its largest production facility, the Whyalla Steelworks in South Australia. For the last four years the company has invested heavily in Whyalla steelworks through a program known as ‘Project Magnet’ to increase capacity, lower production costs and boost the amount of excess iron ore available for export from historical levels of 1mtpa to 4mtpa from FY08.
Most of the $400m capex associated with Project Magnet has already been spent, and with FY08 scheduled as the final year of the program, the benefits are expected to begin flowing over the next few years.
In addition to the benefits of Magnet and strong global steel prices, we expect OneSteel’s earnings to be assisted by its recent merger with Smorgon Steel. Integration and restructuring costs have hampered earnings this year, which is why the stock’s consensus FY08 PE of 20 is at a premium to the market. However, its non-recurring nature suggests a return to normality could be around the corner. With the addition of robust steel prices, higher iron ore exports, production cost savings, merger synergies estimated at $70m, or around 10% of combined group operating earnings, we expect the company to achieve significant earnings growth over the next few years.
The price chart seems to be painting a similar outlook to our fundamental view on the stock. After trending upwards from around $1 in 2001, OneSteel has spent the last year consolidating as part of what appears to be an ascending triangle pattern, which is charaterised by a series of higher lows converging towards a constant resistance level currently above $7. A clear break out from this pattern to the upside would be a bullish signal, however failure of the pattern would occur if the stock broke below recent consolidation levels above $6.
Fundamental risks that could trigger a failure of the current technical pattern include a softening in steel prices from current levels, possibly from a marked slowdown in global or local steel demand. A significant portion of revenues are derived from the local property market. The recent debt taken on as part of the Smorgon merger should also be noted. Although gearing (net debt to capital) remains at the acceptable level of under 40% in the context of the merged enterprise, interest rate pressures could nonetheless eat into earnings, offsetting the positive initiatives discussed. However, despite the risks, we are comfortable with the outlook for the stock and the impact that recent growth initiatives could have on the bottom line over the next few years. Therefore we rate it a ‘buy’ for growth.
Tim Morris is an analyst at wise-owl.com, one of Australia's leading independent stockmarket research houses. Click here for your complimentary report.
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions.
More articles from this edition of CompareShares:
Share tips: Broker Stock Recommendations 11 August – 6 to BUY, 6 to SELL and 6 to HOLD
Taking stock: How to set up a stock watchlist
Advisor Lounge: Ways to get more control over your super savings
Commodities: Commodity of the month – natural gas
Stock picks: Stock of the week – OneSteel
Transport: Rising costs fuel economic stress
Companies: Telstra to outdo profit guidance
Markets: US stocks strong as world oil dives
Turnover: Bendigo, Adelaide Bank 40% profit rise
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