OneSteel is seen as a steel manufacturer but it describes itself as being vertically integrated and “self-sufficient in iron ore”. That
puts it in an interesting position with the signs of demand weakness in China. Vertical integration in part protects the company from being overly exposed to the rise in iron ore prices, its operations suffer less of a margin squeeze than if it was a pure manufacturer. But that protection vanishes if demand falls for both iron ore and steel products, which may be what is emerging from China. Deutsche Bank has a hold on the stock and a price target of only $1.07.
The stock now has to be evaluated as both a manufacturer and a miner according to Deutsche Bank:
Management advised that the expansion of Southern Iron (WPG iron ore assets) was performing in line with expectations and re-iterated it expects the first sales from Q4CY12. Management also advised that it expects the mine to achieve an annual run rate of 5+mpta by FY14, implying a total group run rate of 11+mtpa (Southern Iron and Middleback Ranges combined).
Management expects the costs for the WPG mines to reduce from $70/t to $60-65/t due to increased scale as well as logistics benefits
(Fe=60%). We believe the reduction to WPG operating costs is necessary deliver an NPV in excess of the price paid (OST paid ~$600m including capex vs current valuation of 50cps (~$677m)).On the negative side, if we apply iron ore cost inflation of 8% for the next 5 years (4% in the years following) this reduces the
valuation for the Middleback Ranges. On a combined basis, the NPV for the iron ore business is unchanged at 70cps.Management also advised that through targeting a blend of 60% Fe (53% Middleback, 63% Southern Iron) and lifting its annual sales from 4mtpa to 5mtpa that it believes it will be able to reduce its cost of production from $70/t to $60-65/t post the ramp up. We factor this in to our forecasts ($65/t cost from FY13).
There is upside to Mining Consumables EBIT if management can deliver on its return target of at least WACC. If OST were to deliver WACC returns in FY14, this would lead to an increase to FY14 NPAT of 13%. We currently do not factor this in to forecasts.
The company’s debt position is alright with net debt to equity of 51% and interest cover of 2.4 times. EBIT margins are tight at 4%. Return on Equity (ROE) is only 2.9%. When compared with the cost of capital that looks tight:
Downside risks: continued appreciation of AUD and softer steel prices. Key upside risks include: stabilisation in Australian steel prices, stabilisation of iron ore prices and a faster-than-expected increase in residential and non-residential construction activity.
The stock has sharply underperformed the All Ords since early 2010. But with an average forward earnings multiple of about 12 times the stock does not look too mispriced.
Onesteel (green) compared to All Ordinaries (blue) weekly chart