Australian Steel Sector Update

Submitted by Craig Strzelecki on 18 September, 2007 - 11:37

Australian investors can gain exposure to the steel sector in a number of ways, but a more direct play would be to invest in stocks whose earnings are leveraged to the steel cycle. Australian sharemarket analyst, Macquarie Research Equities (MRE), have provided a steel sector update with the three stocks that stand out. The three outstanding steel sector stocks are OneSteel (OST), Bluescope Steel (BSL) and Sims Group (SGM). The analyst remains bullish on the outlook for the steel sector, and have "Outperform" recommendations on two of three aforementioned stocks. Steel exports from China into Australia were a feature in both the BSL and the OST full-year results. With the stronger Australian dollar, exports into Australia have increased in the first half of this year, particularly in pipe and tube. However, the recent round of government tax policy changes together with stronger steel prices in China has reduced the incentive for Chinese domestic steelmakers to export. This has seen some pullback in exports of steel out of China with four consecutive monthly declines. While exports have visibly slowed they are still up over 40% YoY. The analyst's global commodity team anticipates Chinese steel exports to rise again in the medium to longer term, with limited overseas steel production capacity growth and competitiveness of Chinese steelmakers that are able to produce steel relatively cheaply. This will see the Australian steel industry continue to face increased competition which is unlikely to diminish while the Aussie dollar remains well in excess of US$0.80. The new structure of the Australian steel industry will help address the higher-level imported products. The move by BSL to control the old Smorgon (SSX) Distribution business is a positive for the industry because its focus will be to maintain market share as opposed to increasing market share. Together with OneSteel, the domestic marketplace should be better insulated from imported volumes.

Here are the Australian analyst's steel sector stock recommendations: OneSteel (OST) has an Outperform stock recommendation and a $7.50 share price target. OneSteel remains a good investment story, in the analysts' view, with good exposure to China through iron ore. While imports will continue to be a threat in long products, the analysts see upside risk to the iron ore business and the underlying operations continue to be reasonably successful in offsetting cost pressures. The strategic value of the SSX transaction is not fully known but they feel confident that management can extract value.

Another Australian steel sector stock is BlueScope Steel (BSL) which has a retained Neutral stock recommendation and a $10.50 share price target. The temporary nature of the slowdown in exports out of China will give little reprieve to the competitive pressures felt in 2H07, especially in pipe and tube and galvanised products. The analysts think that this is a large issue to focus on for BSL on a medium-term view, with the 2H07 result highlighting what can happen if Chinese exports ramp up. Together with a higher cost environment, they remain cautious on the outlook for BSL.

Finally the last recommended stock in the steel sector is Sims (SGM) which has an Outperform stock recommendation and a $32 share price target from the analyst. Sims has responded to an ASX query regarding a strong run in the share price and commented that 1Q08 NPAT is unlikely to exceed A$60m, while 2Q08 is anticipated to be stronger. Although there were already expectations for a weaker 1Q08, the more specific guidance is a reminder that the huge 4Q07 result will be difficult to replicate. But The analysts continue to like the more diversified earnings story, and the company remains in a good position to expand via acquisitions. The global market for scrap continues to look favourable and they think that scrap prices will stay at higher levels.

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