Forum Archive Index - December 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

BHP Steel is Australasia's largest and arguably only significant 
manufacturer of flat steel products.  It is the owner of the Port 
Kembla Steelworks in New South Wales.  This is a significant plant by 
world standards, having a capacity of 5.0million tonnes per year - 8 
times the capacity of our own New Zealand Steel facility (also 
owned by BHP Steel).  

Total BSL sales are evenly balanced between 'local' Australia 39%, 
NZ 5% and export Americas 24%, Asia 25% and Europe 7% (year 2000 
figures).    However exports only represent 27% of revenues.  Steel 
sold on the local market is able to differentiate itself and so be 
sold at higher margins because of local knowledge technical support, 
market specific products and shorter lead times.  BSP export sales  
are down 12% in financial year 2001-2002.    BSL no longer hedges its 
foreign exchange and raw material commodity price exposure (steel 
product is sold in $US and iron ore, coal and coating inputs are 
bought in $US).   

Australian sales are 43% to the construction industry (residential,
 non-residential and engineering), 25% to manufacturing and a 
significant 14% to the automotive industry, these being the three 
largest industry group customers.  BSL supplies 80% of the total 
tonnes of flat steel products in the Australian and New Zealand 
markets.  Imports, mostly from Japan and Korea make up the other 
20% and have been growing at a rate of 10% compounded per year.

The jewels of the product portfolio are the coated steel products.
A coated steel product is often the natural choice of roofing for 
both domestic and commercial Australasian building projects.  

BSL are innovative.  For example, they have a technical alliance with 
Nucor Corporation and IHI of Japan,  in developing 'Castrip' ( thin 
strip casting) technology.  This initiative is to market and license 
the intellectual property related to the twin-roll direct casting of 
carbon and stainless steels.   In May 2002, a world first production 
plant of this kind was opened at Crawfordsville, Indiana.  At home 
manufacturing processes are subject to continuous improvement, 
resulting in such innovations as the pulverized coal injection 
system, which this year will save $20m in costs at the Port Kembla 
works.

Steel worldwide is a volatile, capital intensive industry.  For this 
reason BSL was set up as a comparatively low debt company (capital 
structure: 80% equity, 20% debt).    Significant expenditure of  
$280m over 5 years has been made at Port Kembla, which produces 85% 
of BSL's flat steel output.   It is not expected that any major plant 
expenditure will be needed within the next 5 years.  Fortuitous 
commodity pricing of hot rolled product has seen BSL debt levels 
slashed to just 12%, and there is a prospect of eliminating the debt 
entirely.  In summary, the company's equity position is very strong.

A principal reason that BHP Steel (BSL) was spun out of the parent 
BHP Billiton, was to allow the steel side of the business to manage 
its own destiny.   Previously steel profits were siphoned off to fund 
other activities under the BHP Billiton corporate umbrella, like oil 
exploration.   Being the dominant player in Steel production in 
Australia already, it isn't obvious how BSL will rationalize locally 
or how it will end up fitting into a rationalized global picture.    
A merger/takeover offer from the USA seems unlikely given that a 
significant number of steel companies in the US have filed for 
bankruptcy, including some of the largest US steel companies.  In 
Asia, the Japanese, Korean and Chinese steel industries do not have a 
history of wanting to process raw material away from their home soil.

BSL has a policy of paying out 60% of their net profit as dividends.  
Due to losses carried forward into the new company structure when BSL 
was created, it was not anticipated that any of this dividend would 
carry Australian franking credits in FY2003.  Net profit for this 
year is to be artificially boosted by a not to be repeated tax rate 
of 14%.   However, even if we normalize this year's profit based on 
the ongoing 30% corporate tax rate we get earnings of 34.1c per 
share.  This means the dividend of 20c per share is still well 
covered.  If we look back over five years of pro-forma earnings 
figures superimposed on today's costs, we get average earnings of 
24.2c per share per year in the five years to June 2003.  A market 
price of $3.20 per share, the mid December market price, means BSL is 
trading at an historical average P/E of 13.2.  If we apply the 
company policy of paying out 60% of earnings as dividends this means 
an average annual dividend over the business cycle of 14.5cps.  This 
corresponds to a five-year average dividend yield of 4.5%, based on a 
BSL share price of $3.20 (and disregarding franking credits).  

Looking at FY2003 earnings only (44c per share), then the forecast 
P/E improves to  320/44= 7.3, which can be restated as an earnings 
yield of 13.75%.   These are attractive figures as is the projected 
dividend yield of 20/320= 6.25%.   In future years, franking credits 
will make this yield even better, at least to Australian taxpayers.   
 

What we have here is a very attractive present day snapshot of financials
 overlaying a more mediocre five-year business cycle picture.  Hot 
roll coiled steel prices are the most important indicator of 
profitability for BSL.   These prices may be found on the net, and 
are updated monthly here:

http://www.steelonthenet.com/frameSTA.html

Sustained demand for hot rolled steel above the BSL prospectus forecast 
price of $US232 per tonne would see BSL's bottom line benefit 
significantly.  But with world steel making production poised ready 
to take advantage of any significant upturn in price, I wouldn't bet 
on July to November 2002's price of $330/tonne being maintained 
forever.   The large markets set the hot rolled steel price and 
Australasia follows.   It is possible the current spike in hot rolled 
coil price in Europe and the USA is due to cheaper competition being 
shut out by tariffs.   Furthermore because real demand is not 
increasing (some users are building up stock in anticipation of price 
rises, as manufacturers have cut production), it means that European 
and US steel producers will have to cut production again 
significantly to control the supply demand balance.  With an industry 
as fragmented as steel, I don't see it as likely that the relatively 
high prices of the last half of 2002 will be maintained.

A more detailed number crunching discussion of the financials of 'BHP 
Steel' appears on the focus investment group.   To summarize 'BSL' 
did not even come close to our very strict criteria, failing at every 
hurdle.  This doesn't mean BSL is necessarily a poor investment of 
course.   It does mean that company profitability is vulnerable to 
the swings and roundabouts of the markets and that any investment 
decision based on this years and next years view must be tempered.

Right now BSL seems in a kind of sweet spot.  High hot rolled steel 
prices due to voluntary trimming of the supply by price 
setting European and US leading industry players, a solid demand for 
its profitable coated products in Australia, and low debt means that 
any steel downturn is beyond the horizon of most investors.    The 
inaugural dividend in April 2003 should highlight the attractive 
yield for Australians (who have access to franking credits) of 9.4% 
(based on a share price of $3.20, which may go higher by April 2003). 
The annual dividend return for kiwi investors is a less special 
6.25%, which is taxable.

To sum up, what does all this mean for New Zealand investors in BSL?  
BSL is a share that offers a decent dividend yield, that is 
nevertheless nearly matched by OST (OneSteel), but is inferior to 
Steel and Tube (thanks to the benefits of the NZ imputation credit 
system).    As far as share price goes, we can assume it will be 
Australian investors that will drive BSL.  As the April 2003 dividend 
date for BSL approaches I anticipate a surge in interest in this 
share, and even the prospect of a special dividend.    I believe this 
will give kiwi investors a window of opportunity to exit BSL, in 
favour of a share with a similar yield but more growth potential for 
the growth investor  ('OneSteel') or alternatively a better dividend 
yield for the income investor ('Steel and Tube').    In the meantime, 
I would be in no hurry to sell any shares in BSL I owned.   They are 
a very sound company that pays a decent dividend return.  The point 
for kiwi investors is that there are other investments within the 
steel industry in Australia and New Zealand that offer, what I 
believe are slightly better prospects.

SNOOPY

---------------------------------
Message sent by Snoopy 
e-mail  tennyson@caverock.net.nz
on Pegasus Mail version 2.55
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"Sometimes to see the wood from the trees, 
you have to cut down all the trees."



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