Australian Steel Sector

There are three big steel companies listed on the Australian Stock Exchange: Bluescope Steel (BSL), Smorgon Steel (SSX) and OneSteel (OST). Recent global steel production data shows continued strength in the steel market place, with prices also remaining strong. Stock analyst Macquarie Research Equities investigate the positives for Bluescope Steel and OneSteel given this backdrop of a favourable steel pricing environment. The latest International Iron and Steel Institute data shows that world crude steel production was up 10.5% YoY in January-February. China is continuing to lead the way in driving production higher, although the analyst is seeing a slowing in non-Chinese apparent steel demand (primarily due to the US). US production could start to improve going forward now that destocking has started to take place. In the short term, the analyst expects further strong upward pressure on prices. If and when the market moves into over-supply, the analyst expects strong action by steelmakers to defend prices through pulling back production. In any case, the strong growth in Chinese demand may offset the weaker non-Chinese demand and keep the market in close balance between supply and demand. BSL will continue to benefit from the rise in flat product prices. Prices in Asia continue to look strong while the inventory rebalancing taking place in the US has helped to turn US prices around. The 2H07 result is shaping up to be strong and in MRE's view the focus should be on cashflow generation and what BSL does with that cashflow. BSL does have a reputation for returning funds to shareholders, so MRE would expect to see some form of capital management at the FY07 result. Increased construction demand in China will also help to fuel long product prices. Structural beam prices have been particularly strong and the pressure on these prices does not seem to be alleviating. Given the demand environment in Asia, the threat of imports should be reduced. This will help domestic pricing in Australia and this will assist both OneSteel (OST) and Smorgon Steel (SSX). However, prices need to increase, given the increase in raw material costs. Earnings momentum in the steel market remains strong. With demand continuing to be strong, prices are also likely to stay at higher levels. The cost environment is heating up with upside risk to iron ore prices and with scrap staying at a high level. Price increases will be required to offset these costs. The stock analyst believes the short-to medium-term focus for the industry will be the OST/SSX transaction and the role that BSL has to play. At this stage, the analyst is more confident that the deal will achieve ACCC support, however, there are still risks associated with the rebar and merchant bar businesses. News flow on the issue is likely to dominate performance in the short term. The stock analyst maintain their Outperform recommendation for both BSL and OST, with 12 month-price targets of $10.50 and $5.50 respectively.